Effective since August 2012, the European Market Infrastructure Regulation (EMIR) and its various technical standards, notably Commission Delegated Regulation (EU) 2016/2251 regarding collateral requirements, have led to some challenges for European entities participating in the derivatives market. One of these challenges, however, will likely soon be attenuated.

Physically settled foreign exchange (FX) forwards are widely used, especially to hedge FX risk. Under EMIR, all financial counterparties and specific non-financial counterparties trading this kind of product should exchange variation margins as of 3 January 2018. Many non-EU jurisdictions, however, have limited the scope of application of variation margins. Especially for EU institutions trading with non-EU counterparties, this could lead to a competitive disadvantage.

On 18 December 2017, the European Supervisory Authorities (ESAs) published a draft regulation amending Delegated Regulation (EU) 2016/2251, with the intention of levelling the playing field between EU and non-EU entities when it comes to physically settled FX forwards. Specifically, the ESAs suggest limiting the requirement, so that the only variation margins that need exchanging are those for physically settled FX forwards for transactions concluded (1) with "institutions" within the meaning of the Capital Requirements Regulation (CRR), i.e. credit institutions and investment firms, or (2) with an equivalent entity located in a third country that, if it were located in the EU, would meet the definition of "institution."

These amendments will have an impact on the entire European Market because any other entity, financial or non-financial, that is not an institution (i.e. insurance firms, funds, etc.) will also be able to use physically settled FX forwards without exchanging variation margins under EMIR. This will allow European counterparties to remain competitive with entities domiciled in other jurisdictions.

The ESAs stressed, however, that counterparties should nonetheless employ prudent risk mitigation measures to properly identify, measure, monitor, and control risks arising from these transactions until their settlement has been confirmed and reconciled in a way consistent with the requirements of Delegated Regulation (EU) 2016/2251.

What next?

The European Commission (EC) has three months to decide whether to amend the text before endorsing it. After its endorsement by the EC, the delegated regulation will be sent to both the European Parliament and Council for formal approval and publication in the European Official Journal. It will enter into force the day after its publication.

The ESAs are aware that the amendments will enter into force after the requirement to exchange variation margins for physically settled FX forwards did. Consequently, they expect the national competent authorities to apply the EU framework in a risk-based and proportionate manner until the amended regulatory technical standard enters into force.

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