On 1 September, ESMA issued its advice to the Commission on declaring countries outside the EU to be equivalent under EMIR. The good news is that at long last we should have some certainty on what approach to expect. The bad news: we are in for years of frustration as practitioners attempt to nit-pick their way through the new cross-border requirements.
In an ideal world, once a country is granted equivalence, firms and central counterparties/trade repositories (FMIs) regulated in that jurisdiction should be able to provide their services in Europe. Almost like the passport-ing rights that exist within the EU itself. Instead, ESMA’s recommendations are far from a license to play in the common market – in actuality, they are more like an invitation to join the queue at border control.
To explain: ESMA’s advice makes clear that third country equivalence is only the first step for non-EU firms and FMIs on their way to being recognised by the Commission, and that ultimately de facto EMIR compliance cannot be in any way simplified or avoided. In particular, for FMIs they state that equivalence of the FMI’s jurisdiction is simply a pre-condition for applying for recognition from the Commission.
In the details of their recommendations, ESMA has grouped the requirements from other countries into three buckets:
- Equivalent: Good enough for the EU
- Conditionally equivalent: Might be good enough if extra hoops are jumped through
- Non-equivalent: No substitute for EU rules; only EMIR compliance will suffice
Here, once again, G20 regulators have proven their ability to fragment the global market by setting technical standards that don’t line up. Going forward, this means continued uncertainty for firms, CCPs, trade repositories, data vendors and suppliers for the global financial system.
As ever, the devil is in the detail and any summary will miss the thorns buried in the hundreds of rows of detailed rule comparison tables in the annexes. We’ve noted a few examples below to help illustrate the types of challenges that are now associated with ‘equivalence’.
To begin with firms themselves, of the six key requirements under EMIR, four are declared conditionally equivalent (clearing, timely confirmation, portfolio reconciliation and portfolio compression), one non-equivalent (dispute resolution) and one is still TBD (bilateral margins and capital). In other words, only the supervisory and enforcement regime, which contains no explicit requirements for firms has been declared equivalent.
For the rest of the requirements, firms now have to either meet the standard under EMIR or a new different standard set down in the technical standards. For instance, portfolio reconciliation is only deemed equivalent where US counterparties treat FCs/NFCs+ as swap dealers/major swap participants, meaning that US firms need to know the status of their EU counterparties and vice versa, complicating the already complicated counterparty classification problem.
In contrast, the dispute resolution regimes are not declared equivalent and firms will have to be ready for both EMIR and Dodd-Frank compliance depending on where they are trading. Similarly, the decision to delay decisions due to the lack of final US rules complicates creates further uncertainty for firms, increasing costs down the line.
For CCPs, ESMA finds the supervisory and enforcement regimes in the US to be equivalent to those in the EU. However, it takes exception to the US’ rules in several areas including: risk committee requirements, business continuity plans, margining and default fund/waterfall requirements, liquidity risk control requirements, collateral requirements, investment policy requirements and stress testing and back testing requirements – so a short list. For these areas, it recommends the Commission rule that US-based CCPs should have adopted policies equivalent with those required under EMIR in order to merit recognition. In other words, CCPs will need to be EMIR compliant practically across the board.
Similarly, ESMA recommends TRs should have to demonstrate their EMIR compliance in the areas of operational separation and the collection of data on valuation and collateral. However, ESMA does point to the fact that there is the risk of dual reporting for US-based TRs but makes no concrete recommendations beyond this.
This tug of war is far from over. We have yet to really understand the EC’s position – which could well pull in a slightly different direction. In addition, this is a multi-directional tug-of-war, with each jurisdiction holding one end of a rope with every other one. In such a complicated web, who knows how the global market will look once the dust has settled.
Far from achieving a ‘holistic’ equivalence regime, these new recommendations will leave firms sifting over rules (some of which have to be implemented by Sunday) for some time to come. All we can say is: we hope senior management can understand why your Dodd-Frank/EMIR implementation programme has just been extended through 2015…