Classification has hit the global stage and been acknowledged by top journalists as an industry-wide issue.
In a high profile article, Rachel Wolcott, writing for Accelus’ Compliance Complete, sets out the three key counterparty classification issues under EMIR:
- EMIR, which came into force on 15th March, requires firms to classify their non-financial counterparties into those under the clearing threshold (NFCs) and those over it (NFC+);
- ESMA guidance, issued in March, says that firms cannot rely on parties to self-certify NFC/NFC+ where ‘they are in possession of information which clearly demonstrates that those self-certifications are incorrect.’ Therefore, banks can find themselves in trouble in a situation where they ‘should have known’;
- There are few solutions in the marketplace:
- ISDA has put in place an agreement which compels parties to publicise when they breach the clearing threshold. However, this solution suffers from the same problem mentioned above in that, if a party misrepresents its status, its financial counterparty (FC) may still be guilty where it had information to the contrary;
- The BBA has established a web-based system that can classify a party FC/NFC based on an industry code (NIC, NAC, NACE) but does not distinguish between NFC/NFC+;
- Finally, the German regulator, BaFin, has brought in a requirement that NFCs in breach of the clearing threshold must produce an audit certificate to verify that their transactions fall within certain exemptions (hedging, intragroup transactions) or default to an NFC+ after four months. However, there is no equivalent in the UK.
PJ Di Giammarino, CEO of JWG, stated: “It is not beyond the wit of man to put together a solution, but until now there has been limited willingness to take up the problem in an ‘end to end’ manner. Like most EU regulations, EMIR takes a holistic approach to classification based on trading balances that change with market activity, leading to a huge gulf between it and the static nature of classification in the U.S.
Additionally, in EMIR, because there is no one EU regulator that is accountable for pulling the data together, or making that data centrally available to firms, there is a strong likelihood that imperfect information will lead to unintended consequences in the market. In other words, in the absence of a central solution, it is likely that different classifications may be presented to the same counterparty by different banks, making it possible to use regulatory status as a differentiator for commercial purposes.”