Conforming to EMIR Confirmations

Article 11(1) of EMIR requires all financial counterparties (“FC”), non-financial counterparties which have exceeded the clearing threshold (“NFC+”) and non-financial counterparties which have not exceeded the clearing threshold (“NFC-”) to establish “appropriate procedures and arrangements” to ensure the timely confirmation of the terms of all non-cleared OTC derivative contracts.

On 15 March 2013, the majority of the provisions of the EMIR regulatory technical standard dealing with the issue of timely confirmations[1] (the “Risk Mitigation RTS”) will enter into force.  From this date, firms must have policies and procedures in place which will enable them to confirm transactions within specified deadlines.  The exact deadlines will depend on the transaction type, the EMIR status of the counterparties and the date upon which the transaction was executed.  The initial deadlines are as detailed in the table below, although tighter timeframes will subsequently be phased in, beginning on 1 September 2013.

The Practical Impact

In addition, article 12(4) of the Risk Mitigation RTS requires FCs to establish procedures to report, on a monthly basis, the number of unconfirmed OTC derivative transactions that have been outstanding for more than five business days.  In doing so, it provides a regulator with a ‘smoking gun’ as to the state of a firm’s (non) compliance with the timely confirmation provisions of EMIR.  The EU Commission has confirmed that, where a firm has confirmation procedures in place, but still fails to meet the regulatory deadlines, it should notify its competent authority, which should then determine whether the firm has made sufficient efforts to comply with its EMIR obligations.  Adopting a slightly different approach, the FSA has confirmed that FCs do not need to submit an unconfirmed transactions report unless requested to do so, but it does expect policies and procedures designed to assist timely confirmation to be documented before transactions are executed.

According to the Risk Mitigation RTS, the purpose of confirming transactions is “to ensure common understanding and legal certainty of the terms of the transaction”[2].  To this end, confirmations may take the form of “an electronically executed contract or a document signed by both counterparties.”[3]  The approach adopted within ISDA’s recently published “Timely Confirmation Amendment Agreement” (discussed in more detail below) also assumes that a signed document will be required in order to comply with the terms of the Risk Mitigation RTS.

This requirement may come as a shock to those among the dealer community which have traditionally confirmed OTC derivative transactions by way of exchange of confirmations.  Undoubtedly, it will force some to change the way they currently approach this issue.  From a practical point of view, ESMA and the EU Commission seem unapologetic about the potential impact of this requirement, recognising that the “timeframe to achieve timely confirmation requires adaptation efforts including changes of market practice and enhancement of IT systems.”[4]  From a principle point of view, it is difficult to regard the new timely confirmation provisions as unreasonable.  It is a basic requirement of contract law that a ‘meeting of minds’ takes place in order to form an enforceable contract.  Whilst it has the benefit of efficiency, the traditional approach between dealers of exchanging confirmations is really a case of poor practice that has become an industry norm over time.  In many cases, confirmations received are not reviewed and discrepancies are not identified, with the result that it can be questionable as to whether there is any real agreement on the terms of the underlying transaction.  Worse still, in some scenarios this can result in the situation where, at least under English law, disputes are resolved by reference to the rather unsatisfactory legal principle of “battle of the forms”; the ‘last shot’ doctrine whereby the confirmation which was sent latest in time governs the contractual relationship between the parties.  It is also worth bearing in mind that, at least under English law, silence cannot generally amount to acceptance of the terms of a contract.  As such, a process such as that employed by most dealers with their clients, which simply relies upon a lack of response from a counterparty to which a confirmation has been sent (without obtaining the express agreement to such an arrangement by the counterparty in question) also seems fundamentally flawed.

ISDA Timely Confirmation Amendment Agreement

Given the need to reflect the specific capabilities of individual counterparties with respect to the production and review of confirmations, ISDA protocols are not well suited as a means to comply with the timely confirmation provisions of EMIR.  As such, market participants will need to amend their derivative documentation on a bilateral basis.  Fortunately, ISDA has recently published a helpful guide to possible amendments in the form of its “Timely Confirmation Amendment Agreement”.  Whilst parts of the Amendment Agreement are probably not specific enough to form the basis of an executable amendment, it does bring into focus the issues which counterparties will need to consider in this area in that it:

  • enables parties to specify responsibilities and deadlines for the production and agreement of confirmations, by transaction type if required;
  • facilitates both positive and negative affirmation of confirmations, although it remains questionable just how many counterparties would allow a process of negative affirmation (whereby a transaction will be regarded as confirmed if the party receiving the confirmation fails to positively approve/reject the confirmation within a specified deadline) to apply to their transactions; and
  • suggests alternative wording depending on whether breaches should constitute Events of Default, Termination Events or have other consequences.

Next Steps

Any large-scale re-documentation project requires an analysis of a firm’s current capabilities, an understanding of what is required in order to comply with applicable regulation and a plan to move from one state to the other.

Current State Analysis

All market participants, but particularly members of the dealer community, need to understand, per asset class, current capabilities in terms of confirmation production and review.  If coupled with an analysis of the numbers and types of trade a firm has currently executed and/or outstanding with individual counterparties, a counterparty prioritisation list can easily be created.  This provides a valuable tool, both for directing the negotiation process and in mitigating the risk associated with the provision of non-confirmed trade data to regulators.

Desired State Analysis

In principle, the desired state analysis with respect to timely confirmation compliance is relatively easy to perform as it is fully defined within the Risk Mitigation RTS.  However, given the amount of resource required to complete such a re-papering exercise, the greater challenge is to work out the extent to which efforts might be future-proofed so as to avoid the need to revisit documentation again in the near future.  In this regard, it is worth noting that, on 15 September 2013, other provisions of the Risk Mitigation RTS will enter force, including those relating to portfolio reconciliation and dispute resolution, both of which will require further amendments to portfolios of derivative documentation.  Portfolio reconciliation requires FCs and NFCs, before entering into a transaction, to agree in writing the terms upon which their portfolios of OTC derivatives contracts will be reconciled.  The frequency with which a portfolio reconciliation must be performed is dictated by the Risk Mitigation RTS and depends on the type of counterparties involved and the number of transactions they have between them.  Dispute resolution requires FCs and NFCs to agree processes in relation to the identification, recording, monitoring and resolution of disputes relating to the recognition or valuation of an OTC derivative contract and the exchange of collateral.  It also requires FCs to report to their regulator any disputes for an amount or a value higher than EUR 15 million and outstanding for at least 15 business days.

Project Implementation

In practice, project implementation is often the area that causes most problems due to headcount constraints and competing priorities.  Nonetheless, issues to consider at this stage include:

  • identification and prioritisation of clients;
  • confirmation of client contact details;
  • creation of internal negotiation and escalation policies regarding amendments and exceptions;
  • drafting and dispatch of amendment agreements;
  • supplementary client information designed to provide background to amendments;
  • client follow-up schedules;
  • document execution, storage and data capture.

Conclusion

Effecting amendments to a firm’s derivative documentation is a significant undertaking if the underlying portfolio is at all sizable.  Nonetheless, in the context of EMIR, it is a task that cannot be avoided and market participants should be looking at these issues now with a view to implementing amendments on scale and at speed.  Clearly any firm at the beginning of this process will not have completed its amendments by the 15 March deadline.  However, at least for FSA regulated firms, unconfirmed trade data will only have to be provided when actually requested.  Whilst this cannot be interpreted as a licence to do nothing, in practice it is likely to afford an unofficial grace period and should encourage firms to act now as well as provide a degree of interim comfort for those willing to take positive steps to comply.

Copyright © Derivatives Risk Solutions LLP 2013


[1] EMIR Technical Standard regarding “Indirect clearing arrangements, the clearing obligation, the public register, access to a trading venue, non-financial counterparties, and risk mitigation techniques for OTC derivatives contracts not cleared by a CCP”

[2] Risk Mitigation RTS, Recital 27

[3] Risk Mitigation RTS, Recital 26

[4] Risk Mitigation RTS, Recital 38