The European Market Infrastructure Regulation (EMIR): an overview

The European Market Infrastructure Regulation (EMIR) is a governance tool for over the counter (OTC) derivatives, introduced by the European Commission.

The measures in EMIR aim to regulate $15.5 trillion worth of transactions that have previously facilitated a high risk environment for trade by lacking transparency. 

History of the European Market Infrastructure Regulation

The European Market Infrastructure Regulation (EMIR) was initially introduced in 2012 in order to combat transparency issues and risk in the OTC markets.

OTC refers to the over-the-counter sale of a financial instrument, covering everything from food prices to mortgages. But since each derivative transaction is often very small, there is a lack of regulatory scrutiny and high level of systemic risk. A very high proportion of everyday transactions occur within the OTC markets; which is why the problems needed to be addressed.

EMIR was introduced by the EU in order to increase the reporting of OTC derivatives contracts, making them available to supervisory authorities. Furthermore, the regulation exists in order to reduce credit risk by ensuring that the trade repository processes your transactions in a very specific, approved way. 

Key provisions of EMIR

The features of EMIR pertain specifically to increasing the availability of information into the public domain, as well as the introduction of risk mitigation techniques within transactions.

Central Clearing Parties

A central clearing party (CCP) is an approved contractor who works from both sides of a transaction; a buyer to every seller and a seller to each buyer. EMIR enforces every derivative contract (above a certain threshold) to go through CCPs. This increases transparency since a third party is involved. 

Within the clearing obligation, the two original financial counterparties no longer have a direct contract with each other. Instead, the clearing member facilitates the deal from both sides to reduce risk. The biggest incentive for clearing is that it regulates capital costs and ensures that pricing is fair across the board. Clearing also provides access to a larger set of counterparties, which means that parties can get a better ‘deal’.

Risk mitigation

Risk mitigation regulation applies to any financial counterparty who do not meet the threshold for central clearing parties. According to the European Markets and Standards Authority (ESMA), this includes EMIR obligations around:

• Timely confirmation
• Portfolio reconciliation
• Specific dispute resolution procedures

Operational risk mitigation is a major part of EMIR compliance since transactions become both measured and monitored. It significantly reduces the chance of mistakes and increases financial stability.

Who must comply?

The European Market Infrastructure Regulation applies to both financial and non-financial related counterparts in the OTC market. For example, banks, insurers and pension funds all fall under EMIR regulation.

Financial institutions who meet the clearing threshold are required to process transactions through a central counterparty. Alternatively, a non financial counterparty that does not meet the clearing threshold must implement risk mitigation measures within their transactions with another market participant.

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