Brexit and EMIR Clearing

As a Brexit migration measure, ESMA is proposing to amend the EMIR clearing obligation so as to allow EU27 counterparties to novate contracts with UK counterparties to other EU27 counterparties without triggering the EMIR clearing obligation. ESMA’s proposal, which was published on 8 November 2018 (here), is designed to support counterparties’ Brexit preparations and maintain a level playing field between EU counterparties, while addressing potential risks to orderly markets and financial stability.

Post-withdrawal, a UK counterparty may not be able to execute certain operations in relation to derivative contracts entered into with an EU counterparty, including so-called “life-cycle events” (such as novations, unwinding by entering into an offsetting transaction, compression with new replacement contracts, etc.). As a result, the parties may decide to replace the UK counterparty with a new EU27 counterparty (e.g. an EU affiliate of the UK counterparty).  Such replacement would typically be effected by novation and, as such a novation would result in a new contract between the original EU27 counterparty and the new EU27 counterparty, that new contract would be subject to the EMIR clearing obligation if it occurs on or after the date from which the clearing obligation takes effect for that type of contract. As a result, the parties to that new contract would have to clear it through a CCP that is authorised or recognised for EMIR purposes.

ESMA’s proposed exemption will allow UK counterparties’ OTC derivative positions to be novated to other EU27 counterparties without triggering the EMIR clearing obligation. The proposed exemption is strictly limited in scope to novations of OTC derivative contracts that effect the replacement of a UK counterparty by an EU27 counterparty; no other amendments that would bring the amended contract in scope for the clearing obligation are protected. Moreover, the relevant novation must be carried out between the proposed date of application of the amending regulation and one year after the UK’s withdrawal from the EU.  It is proposed that the amending regulation will apply from the date following that on which EU law ceases to apply to the UK pursuant to Article 50(3) of the Treaty on European Union but that it will not apply if:

  • a withdrawal agreement concluded with the UK in accordance with Article 50(2) of the Treaty on European Union has entered into force by that date; or
  • a decision has been taken to extend the two year period referred to in Article 50(3) of the Treaty on European Union,

reflecting the fact that the proposal is specifically designed to address the negative implications of a no-deal Brexit.

In order to benefit from the proposed exemption, each EU27 counterparty should start negotiating the novations of its transactions which are in the scope of ESMA’s proposed exemption as soon as possible, given the 12-month time period to benefit from it. Should the parties agree on the terms of a novation before the proposed exemption’s date of application, they should provide that the novation would take effect only upon that date of application.

The ESMA proposal referred to above does not provide any relief in relation to the potential triggering of the EMIR margining requirement by novations that are in scope for that proposal. Such relief would be the joint competence of all 3 European Supervisory Authorities (ESAs) which, according to ESMA, are considering measures to address this point. 

Importantly, ESMA expressly acknowledged that stakeholders had sought a more general grandfathering for legacy OTC derivatives contracts between UK and EU counterparties but confirmed that it considers such grandfathering would neither be appropriate nor within its mandate.  It has also emphasised that the above mentioned measures will be the only regulatory measures the ESAs intend to propose with respect to non-centrally cleared OTC derivative contracts, to help address the legal uncertainty raised by the withdrawal of the UK from the EU and to ensure a level-playing field between EU counterparties.

This document has been prepared by McCann FitzGerald LLP for general guidance only and should not be regarded as a substitute for professional advice. Such advice should always be taken before acting on any of the matters discussed.