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The domino effect: The snowballing cost of getting EMIR wrong

As more EMIR deadlines approach, some regulatory positions are being reinforced, giving firms more reason to fear penalties and the growing legal stakes.  However, a delay to a reporting deadline because ‘ESMA realised that more guidance was needed given the complexity of the issue’ begs the question:  Can regulators say for certain that more unknown unknowns do not exist elsewhere, especially when they are upping the stakes for non-compliance in other areas?

ESMA has delayed the implementation of exchange-traded derivative (ETD) trade reporting under EMIR until January 2015 (here).  This, ESMA concedes, is due to them having overlooked the complexity of identifying the counterparties to a trade, which changes depending on the perspective from which you are reporting and the time at which you take the snapshot.  As such, ESMA has put back the reporting deadline in order to issue more detailed technical standards on the matter.

However, those that are battling their way through implementation programmes are well aware of many other issues that have not received such relief. The reality elsewhere is that battle lines are being drawn and regulators are taking tough positions that they will use in their ‘thematic reviews’ of how well the industry has adjusted to the new rules of the game.

Regulators are viewing 15 September as the date by which firms must have classified their counterparties in order to remain compliant.  As our previous article highlights, by 15 September firms must have portfolio reconciliation and dispute resolution agreements in place with their non-financial counterparties (NFCs).  And yes, there is a right answer and a wrong answer; firms will likely be assessed for consistency in their classifications.  Clearly, regulators will be able to see classifications both within and across firms.  This means a slap on the wrist for those firms that have incorrectly classified their counterparty.  How will the regulators know?  Because NFCs, if they change status to be NFC+ (or, change back to NFC) are required to notify the regulators, who then hold a secret master list.

However, the stakes are still being raised.  This classification will not only support many aspects of EMIR implementation, including the clearing obligation (arguably the centrepiece), but also requirements from CRD IV, such as that the right amount of capital be held for OTC exposures (read more here).  Therefore, for each instance of non-compliance on the classification side, there is the potential to be found non-compliant many more times across the firm.

And the classification of EU firms is just one problem of many which requires resolution.  The 5 August ESMA Q&A (here) highlighted a number of issues just as large as the reporting issue:

• Finding the status of entities established in a 3^rd country (see OTC Question 13);
• The hedging definition for exempting trades from the NFC/NFC+ clearing threshold (see OTC Question 10);
• Daily reporting of marked-to-market collateral/valuation (see TR Question 3);
• Reporting standards including the use of the LEI and any Unique Product/Transaction Identifier (UP/TI) in the future (see TR Question 10).

Whatever the regulators’ plans for enforcing these requirements, it is now too late for them to postpone fast-approaching deadlines.  As such, firms’ near-term solutions will inevitably be ad hoc and limited in scope, potentially creating systemic risk problems further down the line.  The question is, how will firms continue to refine their target operating model to meet the multiple deadlines going forward and avoid causing a non-compliance chain reaction?