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EMIR (European Market Infrastructure Regulation) is a set of union laws made by the European Union to safeguard transactions and increase transparency of the over-the-counter (OTC) and other exchange-traded financial derivatives. It aims to reduce counterparty credit risk and operational risks for preventing economic collapse during a financial crisis like the 2008 financial crisis. Trade repositories were established to register OTCs by European Securities and Marketing Authorities (ESMA) under the EMIR laws.

Affected Entities

Entities such as banks, corporations, funds, Pension fund companies, insurance companies, and other financial firms that are in the European Union and participate in OTC derivative contracts are subjected to EMIR laws. They form the contracts to trade or hedge against foreign exchange interest rate for minimizing risks and exposing themselves to various other opportunities and assets of the market. These institutions after entering the contract are classified as counterparties under EMIR. The classification is divided into two: Financial counterparties (such as banks, brokers, insurance companies, and more) and Non-Financial counterparties.

Elemental points of EMIR

  • Clearing: Counterparties and some non-counterparties have to go through the mandatory obligation of clearing their large derivatives through the central clearing counterparties (CCP) as pronounced by ESMA under the EMIR laws. It is the process by which two parties of an OTC derivative contract forms separate contracts with CCP. The parties form a contract with the CCP making it the counterparty to the original counterparties, such that it no longer has a contract with each other. This clearing regulation is done to promote minimizing the credit risk factors with counterparty’s transaction. It applies to the relevant class of OTC as mentioned and classified by ESMA. Clearing models include a market participant becoming a clearing member of CCP, a client of CCP, or a client of CCP’s clients.

  • Reporting: The data obtained from counterparties and OTC derivatives reports are presented to the trade repositories. These repositories maintain data with confidentiality and high security as per the guidelines of the EMIR laws. Reporting to the repository, promotes transparency of the derivatives market and market participants, to give an accurate outlook to the regulators to minimize risk. Though the data gathered are accurate, it lacks standardization of the data presented across various products in the market. Information such as derivative contracts and the data regarding the counterparties of the derivative contracts has to be revealed to the trade repository of ESMA. The market participants have to obtain global Legal Entity Identifier under the EMIR Act to reveal the counterparty data.

  • Risk mitigation techniques: The process is done to avoid systemic risk in the economy during the major financial crisis. It applies to the OTC derivatives that are not cleared by the CCP to promote risk management. The new obligations applied on the mentioned OTC derivatives are daily market valuation, trade confirmation of counterparties on time and according to the regulation of EMIR, disputes resolution procedure, variations in margining and initial margining, capital requirements, and more. The frequency of reconciling portfolios of the counterparties depends on the counterparty classification as per the guidelines of the EMIR and the number of OTC contracts. EMIR requires its European Economic Area (EEA) and non-EEA members to have an approved procedure to identify, and detailed reports of collateral exchange and disputes regarding contract recognition or valuation.

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