31.01.2025

Over-the-Counter Derivatives

The Regulation on European Market Infrastructure (EMIR) sets out the rules relating to over-the-counter (OTC) derivative contracts, central counterparties (CCPs), and trade repositories, in accordance with the agreements of the G-20 established in Pittsburgh (United States) in September 2009.

The EMIR Regulation aims to reduce systemic risk, increase transparency in the OTC derivatives market, and safeguard financial security.

It has been amended several times, most recently by Regulation (EU) 2022/2554, the Digital Operational Resilience Act (known as DORA), which aims to ensure that the financial sector maintains its resilience during a severe disruption of activity.

Key Points:

To improve transparency, EMIR requires that all information relating to all European derivative contracts be communicated to trade repositories and made available to supervisory authorities, including the European Securities and Markets Authority (ESMA).
To reduce counterparty credit risk, EMIR establishes strict organizational, commercial conduct, and prudential obligations for CCPs. Standard derivative contracts must be cleared through CCPs (see clearing).
With a view to strengthening the digital operational resilience of the European Union (EU) financial sector, the amending Regulation (EU) 2022/2554 sets out the requirements for the resilience of the networks and information systems of CCPs and trade repositories to ensure that they can withstand, respond to, and recover from all types of ICT-related disruptions and threats.
To reduce the operational risk of OTC derivative contracts that are not centrally cleared, the EMIR Regulation requires counterparties to have firm procedures for the timely confirmation of contract terms, to identify and resolve disputes at an early stage, and to perform daily mark-to-market valuation of the value of outstanding contracts. Additionally, counterparties must exchange collateral and ensure that they have sufficient capital to manage the risk not covered by the collateral.
The clearing and reporting obligations apply to companies that have significant holdings in OTC derivatives, including:
- financial firms, such as banks and insurance companies;
- non-financial firms, such as energy companies and airlines.

Exemptions

Intragroup transactions are exempt from the central clearing requirement, reporting, and the obligation to exchange margins on non-centrally cleared OTC derivatives under certain conditions.
Pension schemes are temporarily exempt because a viable solution has not yet been developed to allow pension schemes to participate in central clearing.
Certain public entities and international institutions are outside the scope of the EMIR Regulation (with the exemption for reporting depending on the entity).
In certain circumstances, the clearing obligation for certain OTC derivative contracts or certain counterparties may be suspended.

Responsibilities of the European Securities and Markets Authority

ESMA is responsible for identifying the contracts that must be subject to the clearing obligation, i.e., those that are standardized and subject to clearing by CCPs.
ESMA plays an important role in ensuring greater harmonization and cooperation within the EU among the authorities of the EU Member States responsible for supervising EU CCPs.
ESMA is responsible for the recognition of CCPs from non-EU countries wishing to offer clearing services in the EU and supervises non-EU CCPs that are systemically important for financial stability in the EU or in one or more of its Member States (Tier 2 CCPs).
Additionally, ESMA supervises trade repositories.
The amending Regulation (EU) 2022/2554 requires ESMA to develop draft regulatory technical standards to specify the minimum content and requirements of the business continuity policy and disaster recovery plan, excluding the ICT business continuity policy and disaster recovery plans.

Competencies

The EMIR Regulation establishes the competencies of:
- the national competent authorities, the colleges of supervisors, and ESMA for the authorization and supervision of CCPs established in the EU;
- ESMA, the college of non-EU country CCPs, and the central banks issuing the currencies of the EU for the recognition of third-country CCPs and the ongoing supervision of Tier 2 CCPs’ compliance with EMIR.
The European Commission has adopted a series of delegated regulations that include technical standards based on ESMA’s drafts to implement the terms of the Regulation. The technical standards developed by ESMA cover a range of topics, including:
- the capital requirements of CCPs;
- the minimum data to be reported to trade repositories;
- the supervisory information of entities on the liquidity coverage requirement.
It also has the power to adopt delegated regulations on various aspects, including:
- amendments to the list of entities exempted from the provisions of the Regulation;
- the internal regulation relating to the imposition of fines and coercive fines;
- measures to amend Annex II to take account of the evolution of the financial markets;
- the additional specification of the type of fees, the concepts for which they will be payable, the amount of the fees, and the method of payment.
It has adopted implementation decisions on various issues, including the equivalence of the regulatory regimes of CCPs in certain non-EU countries.

When did the Regulation come into force?

It has been in force since August 16, 2012.

Background

OTC derivatives are usually traded privately. Consequently, information about them is only available to the contracting parties, which can make it difficult to determine the nature and level of the risks involved.

For more information, see:

Key Terms

Over-the-Counter (OTC) Derivative. A derivative is a financial contract linked to the future value or status of the underlying entity to which it refers, such as an asset, an index, or an interest rate. An over-the-counter derivative is a derivative that is not traded on an exchange or equivalent market outside the EU but is negotiated privately between two counterparties, such as a bank and a manufacturer.

Central Counterparty (CCP). A body that intermediates between the two counterparties of a transaction, acting as a buyer to every seller and as a seller to every buyer. The main objective of a CCP is to manage the risk of a counterparty that cannot make the required payments at maturity, i.e., defaults on the agreement.

Trade Repository. A data collection center to which the details of derivative transactions are reported. Trade repositories are commercial companies. There are international trade repositories for over-the-counter credit, interest rate, and capital derivatives (a particular category of derivatives, such as options or futures).

Counterparty Credit Risk. A risk that a counterparty, i.e., the other party in a financial transaction, defaults on payment.

Clearing. All activities from the moment a commitment is made for a transaction until it is settled.

Operational Risk. A risk of loss resulting from incorrect or faulty internal processes or external events, such as fraud, human error, or terrorism.

Mark-to-Market Valuation. Assigning a value to an asset equal to the current market price of the asset or calculated based on related standardized assets for which there is a market.

Main Document

Regulation (EU) No. 648/2012 of the European Parliament and of the Council of July 4, 2012, on over-the-counter derivatives, central counterparties, and trade repositories (OJ L 201 of 27.7.2012, pp. 1-59).

Successive amendments to Regulation (EU) No. 648/2012 have been incorporated into the original text. This consolidated version is for information purposes only.

An Analysis of Its Main Topics

Regulation (EU) No. 648/2012 of the European Parliament and of the Council of July 4, 2012, on over-the-counter derivatives, central counterparties (CCPs), and trade repositories seeks to strengthen financial stability and transparency in derivative markets. Below is an analysis of its main topics and provisions:

I. Scope of Application and Key Definitions

The regulation applies to financial counterparties (investment firms, credit institutions, insurance undertakings, etc.) and, in some cases, to non-financial counterparties operating with over-the-counter derivatives.

Exceptions:

Members of the ESCB, bodies with similar functions, and other public bodies responsible for managing public debt.
Bank for International Settlements.
Multilateral development banks.

Key Definitions:

Derivative: “a financial instrument listed in Annex I, Section C, points 4 to 10, of Directive 2004/39/EC.”
Non-financial counterparty: “an undertaking established in the Union other than the entities mentioned in points 1 and 8.”
Pension schemes: Includes occupational pension funds, entities managing them, and other entities or national systems providing retirement benefits.

II. Clearing Obligation

The regulation establishes criteria for determining which categories of over-the-counter derivatives must be cleared through a CCP. The European Securities and Markets Authority (ESMA) plays a fundamental role in this process.

Criteria for the clearing obligation:

Reduction of systemic risk.
Level of contractual standardization.
Volume and liquidity of the derivative category.
Availability of information on price formation.

III. Non-Financial Counterparties

Non-financial counterparties are subject to the clearing obligation if their positions in derivatives exceed a certain threshold. Global hedging and risk mitigation strategies of the counterparty are considered.

(Article 10): “When a non-financial counterparty takes positions in over-the-counter derivative contracts and these positions exceed the clearing threshold specified in paragraph 3, the non-financial counterparty shall be subject to the clearing obligation […]”

IV. Exemptions from Obligations

The regulation provides for exemptions for certain intragroup transactions and for contracts that reduce risks directly related to commercial or treasury activities.

(Article 3): Defines intragroup transactions, specifying conditions for financial and non-financial counterparties.

(Article 11): “Financial and non-financial counterparties may be exempt from the obligation to provide collateral for the intragroup transactions referred to in Article 3.”

V. Authorization and Supervision of CCPs

The authorization and supervision of CCPs fall under the competent authority of the Member State where the CCP is established, with the participation of a college of supervisors that includes the competent authorities of other Member States and ESMA.

(Article 14): “Authorization to operate as a CCP shall be granted by the competent authority for the CCP after consulting ESMA.”

(Article 17): Describes the authorization process, including the creation of a college of supervisors.

VI. Recognition of Third-Country CCPs

ESMA may recognize CCPs established in third countries to provide clearing services in the Union, provided that the legal and supervisory framework of the third country is equivalent to that of the Union.

(Article 25): “ESMA may recognize a CCP established in a third country to provide clearing services in the Union.”

VII. Risk Management and Financial Resources

CCPs must have a robust risk management model and adequate financial resources to cover their risk exposure. The regulation sets out capital, margin, and collateral requirements for CCPs.

(Article 41): “CCPs shall have sufficient financial resources to cover, at a minimum, the total amount of their risk exposures in a scenario of default of their two clearing members with the highest risk exposures.”

VIII. Trade Repositories

The regulation establishes the obligation to report the details of derivative transactions to trade repositories. ESMA is responsible for the registration and supervision of these repositories.

(Article 9): “Market participants shall report the details of any derivative contract they have concluded to a trade repository […].”

IX. Sanctions

Member States must establish sanctions for non-compliance with the regulation. ESMA may also impose sanctions on trade repositories.

(Article 12): “Member States shall determine the sanctions regime applicable in the event of a breach of the provisions of this Title […].”

X. Transitional Provisions

The regulation includes transitional provisions, such as the temporary exemption from the clearing obligation for certain pension schemes.

(Article 89): “For the three years following the entry into force of this Regulation, the clearing obligation set out in Article 4 shall not apply to over-the-counter derivative contracts that objectively measurably reduce the investment risks directly related to the financial solvency of pension schemes […].”

If you liked this article, you may also find it interesting to read the following one:

EMIR: A Regulatory Framework for OTC Derivatives

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