The findings from our 2014 review on how non-financial counterparties (NFCs) calculate the clearing threshold and how they are complying with European Market Infrastructure Regulation (EMIR).
Why we did this review
We wanted to understand how NFCs are defining their hedging activity and monitoring their status against the clearing threshold. We focused on the compliance obligations that now apply to NFCs.
This review, which we conducted during June 2014, focused on energy producers and oil producers, and we agreed follow-up actions with NFCs that were not in compliance with EMIR. As part of our supervisory approach, we will select other sectors of the economy and meet with relevant NFCs to ensure they are complying with the EMIR regulations.
NFCs’ approach to calculation of the clearing threshold, and identification of hedging and non-hedging transactions.
Overall, we found that NFCs were accurately classifying hedging and non-hedging transactions. Here we outline some further findings.
- NFCs had set up internal training to educate staff on the EMIR requirements and ensure consistent interpretation of the EMIR provisions applying to NFCs. This included in relation to calculating OTC derivative contract positions entered into by the NFC or other non-financial entities within the NFC’s group which were not for hedging purposes. Also, in relation to establishing which transactions were not for hedging purposes.
- A significant part of NFC derivatives’ trading has migrated from over the counter (OTC) to exchange, allowing the clearing of trades and exclusion from the clearing threshold calculation obligation set out in EMIR Article 10(3).
- Following our statement on the definition of a financial instrument in physically settled gas and power forwards, the NFCs we met were either no longer trading on MTFs or had reduced their MTF trading activity. This is more a result of the changes the brokers made to their platforms than a change in behaviour of the NFC.
- Some NFCs were previously using a macro Value at Risk (VaR) approach to identify hedging transactions and calculate against the clearing threshold. However, since the ESMA OTC Q&A was published, NFCs have stopped using this approach. Instead, the NFCs have opted for a trade tagging system to ensure that each trade is identifiable as either a hedge or a speculative trade, with the latter counting towards the clearing threshold.
- Persons entering into OTC derivative contracts on behalf of NFCs are governed through controls set by the NFCs such as trading limits to ensure they do not breach their mandate to enter into hedging transactions and inadvertently enter into speculative positions. NFCs also made reporting to a committee a requirement if a breach in the mandate has occurred.
- NFCs demonstrated that persons entering into OTC derivative contracts on their behalf were aware of the decisions made as part of the trading strategy and, where a trade is entered into as a hedging transaction, how these could be justified, evidenced and linked to an underlying hedging purpose. Persons entering into OTC derivative contracts on behalf of NFCs were aware of the time horizon, net position and nature of their trades, which is in line with the business needs when hedging.