“Facing Regulation & Compliance together”

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Highlights 2013 02

author: co 3S AG | June 2013

EMIR a derivative reform in a nutshell

EMIR is the acronym for the European Market Infra-structure Regulation which came into force on 4 July 2012 and lays down clearing and reporting require-ments for over-the-counter (OTC) derivate contracts, implies new risk mitigation requirements for uncleared OTC derivates and uniform requirement for the perfor-mance of activities of central counterparties and trade repositories.

“Facing Regulation & Compliance together”Care of 3 Services

Highlights 2013

EMIR is complemented by MiFID 2/ MiFIR, which will introduce, inter alia, requirements for trade transparency and mandatory electronic execution of recognized OTC trades through the Organized Trading Platforms (OTFs) and aligned with the Capital Requirement Directive for financial institutions ("CRD IV").

Main obligations under EMIR

Reporting obligation – article 9 of EMIR requires counterparties, financial and non-financial, and also Central Clearing Counterparty (CCP) to report details of all derivate contracts (whether clear or not cleared) traded on an exchange or OTC, to Trade repositories. Re-porting obligation may be delegated, and counterparties and CCPs have an obligation to ensure that details of their derivate contracts are reported without duplication.

Reporting obligation applies to all derivate contracts which were en-tered into before 16 August 2012 and remain outstanding on that date and also to those which entered into on or after 16 August 2012.

Under EMIR the reporting data shall be reported no later than the working day following the conclusion, modification or termination of the transaction. Historical data should be reported from August 16, 2012. The required reporting data can be segregated into two cat-egories, (i) the “common data” which is essentially the agreed trade and lifecycle data, and (ii) the “counterparty data” which tends to be more confidential in nature because they will relate to beneficial owner, collateral etc.

EMIR imposes the reporting obligation to both OTC and listed deri-vates. It also requires the reporting of the collateral associated with the derivate trades.

Clearing obligation applies to all OTC derivates concluded be-tween qualifying counterparties which have been identified as eligi-ble for clearing through CCP by European Securities and Markets Authority (ESMA). There are two ways to determine clearing eligi-bility: (a) “Bottom up” – ESMA is notified when a CCP is authorised to clear a class of OTC derivates and then ESMA will determine whether the clearing obligation should apply to such contracts and (b) “Top down” - ESMA identifies classes of derivates that should be cleared, but for which no CCP has received authorisation.

According to EMIR there are certain exemptions from clearing obliga-tion for certain counterparties such as: (i) a partial exemption which applies only for non-financial counterparties where their position fall below a clearing threshold (excluding positions entered into for pur-poses of hedging commercial and treasury activity), it will be deter-mined by ESMA; (ii) certain pension schemes are exempt from the clearing obligation for three years from the date of entry into force of EMIR, and in relation to reduce their investment risk. But they are still subject to the bilateral risk-mitigation techniques requirements; (iii) intra-group transactions – the exemption is available where entities are in the same consolidation.

Deadlines for reporting and mandatory clearing ob-ligations

Reporting entities are likely to start fulfil reporting obligation on Sep-tember 23, 2013 regarding credit and interest rate derivates, and January 1, 2014 for FX, equity and commodity derivates.

Regulatory technical standards which will be published by ESMA to define which products will be subject to mandatory clearing has moved to March 15, 2014. The latest date has been moved to Sep-tember 15, 2014.

author: co 3S AG | June 2013

“Facing Regulation & Compliance together”Care of 3 Services

Highlights 2013

Collateral

Article 43 of EMIR sets out the collateral requirements for derivates that are cleared through CCP. Regarding cleared transactions all coun-terparties must pay initial and variation margin in highly liquid collat-eral (cash, gold, government bonds, etc.) to the CCP. Regarding un-cleared transactions financial and non-financial counterparties (above the clearing threshold) must have in place procedures for “the timely, accurate and appropriate segregated exchange of collateral”. This may be in form of initial margin, variation margin or both.

Collateral obligation came into force on August 2012 but margin re-quirements for non-centrally derivates are still pending.

Financial counterparties are required to hold appropriate capital to cover risks not covered by collateral. In addition to exchange of col-lateral, for uncleared transactions, financial counterparties and non-fi-nancial counterparties need to put in place arrangements to measure, monitor and mitigate operational and credit risk, including require-ments for electronic confirmation, portfolio valuation and reconcilia-tion. These obligations also apply to non-EU entities in some circum-stances. The detailed requirements will be set out in technical stan-dards after consultation.

author: co 3S AG | June 2013

LIBOR reform summary

The Libor scandal arose when it was found out that banks were falsely inflating or deflating their rates with intention to profit from trades, or to give the impression that they were more creditworthy than they were.

“Facing Regulation & Compliance together”Care of 3 Services

Highlights 2013

Potential implication of LIBOR reform on Investment Managers

The LIBOR reform might have potential impact on existing finance documentation referred to LIBOR benchmark, which will need to be amended due to the fact that the British Bankers' Association (the BBA) should transfer its responsibility as LIBOR administrator to a new administrator. Moreover the BBA should cease publication of LIBOR for those currencies and maturities for which there is insuf-ficient trading volume (such as Australian dollar, Canadian dollar, Danish krone, New Zealand dollar and Swedish krona) and that for the remaining currencies, the 4, 5, 7, 8, 10 and 11 month maturities should no longer be published. This would very significantly reduce the number of LIBOR rates published from the current 150 to 20. These rates would be phased out in a 12-month period, or potential-ly earlier, in consultation between the BBA and the market.

The proposed changes in LIBOR benchmark process settings may have an impact mostly on the need to review clients´ contracts (trans-actions) where the LIBOR definitions and benchmarks are used. Hence, it would be appropriate to establish contingency planning and/or alternative benchmarks for any particular types of transactions in case of disruption or discontinuance of certain LIBOR currencies and maturities. The majority of contracts expressed in the main currencies will remain effective by reference to LIBOR as calculated and published in accor-dance with the reforms.

UK Authorities´ response to LIBOR scandal

As a result of the Libor manipulation the Britain’s Financial Service Au-thority (FSA) proposed the following changes to LIBOR:

1) The administration of and submissions to LIBOR should be reg-ulated activities. Any attempt to manipulate LIBOR will trigger civil and criminal sanctions. 2) The British Bankers' Association (the BBA) will be replaced by a new administrator who will compile and distribute the rate and pro-vide oversight. 3) The new administrator should introduce a code of conduct gov-erning submissions process. 4) Banks that do not currently participate in submissions to LIBOR will be encouraged to do so, to increase the sample size and there-fore the benchmark's accuracy and credibility. 5) Compilation and publication of LIBOR should cease for curren-cies and maturities where there is insufficient trade data to corrobo-rate submissions. 6) UK authorities should work closely with their European counter-parts and the wider international community to debate the long term future of LIBOR and other global benchmarks. 7) Market participants are encouraged to re-evaluate use of LIBOR and adequacy of contractual fall-back provisions in the context of fail-ure of LIBOR.

The European Commission’s reaction to Bench-mark-setting

Due to the LIBOR scandal and with the aim to avoid this kind of market manipulation in the future, the European Commission put forward proposals to amend (i) the Regulation and (ii) Directive on insider dealing and market manipulation, including criminal sanc-tions. These amendments will clearly prohibit the manipulation of benchmarks, including LIBOR and EURIBOR, and make such ma-nipulation a criminal offence. Also ESMA and EBA put together the proposal of principles for Benchmarks-Setting process in the EU.

author: co 3S AG | June 2013

How tomatoes became vegetables...

How tomatoes became vegetables according to the U.S. Supreme Court.

“Facing Regulation & Compliance together”Care of 3 Services

Highlights 2013

Declaration of the highest authority

There has been an old-age debate whether a tomato is a fruit or a veg-etable. If someone raises this debate in front of you, you can show off your legal acuity (or nerdiness) by informing them, that is has been of-ficially declared by the highest authority that tomatoes are vegetables. And who is the highest authority? The U.S. Supreme Court.

More than 100 years ago, Justice Horace Gray, speaking on behalf of a unanimous Supreme Court, ruled that a tomato is a vegetable as a matter of law. The Tariff Act of 1883 declared a 10 percent duty on all vegetables entering the country, but allowed fruit to enter duty-free. The New York Customs Collector saw an opportunity to increase rev-enue and declared the tomato to be a vegetable.

Angry importers sued and their case reached the Supreme Court, where Justice Gray said: “Although botanists consider the tomato a fruit, tomatoes are eaten as a principal part of a meal, like squash or peas, (and all grow on vines), so it is the court’s decision that the tomato is a vegetable.”

Sometimes judge´s decision is more powerful than laws of nature.

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