March 24, 2021

EMIR is the EU regulation to reduce the systemic risk of OTC derivatives by setting guidelines for reporting to the regulators, making clearing mandatory for a large proportion of the trades and setting minimum standards for operational and financial risk. In addition, it regulates the clearing infrastructure in Europe.

This regulation originates from 2012 and was most recently updated with EMIR Refit in 2020.

At first glance one can look back satisfied as big incidents around derivatives have not taken place. Incidents such as with Metallgesellschaft AG, Vestia housing and Barings all took place before that. The financial crisis and banking crisis in 2007-2008 did make the regulators aware that they had insufficient sight on the derivatives and where these risks eventually reside. To prevent similar situations in future the G20 decided that these risks had to be managed better. The Bank for International Settlements (BIS) in Basle, the cooperation of Central Banks drafted the way this could be achieved. A good start, the best you could have I would say.

Unfortunately, the subsequent translation of the BIS template into national legislation led to similar, but not equal regulations around the globe. Fortunately for Europe, the EU took the lead and issued one regulation which is applicable for all EU countries. This is a significant achievement as it captured 28 countries in one go! To compare, in the US 4 different regulators came up with a regulation resulting in 4 slightly different sets of rules in the US depending on the kind of institution and whether it is regulated by FED, CFTC or others.

Europe amended its EMIR regulation in 2019 by introducing the EMIR Refit changes. While this made the regulation less burdensome for small players, by introducing new types of counterparties such as ‘Small FC’, and because Non Financials can now suddenly be considered NFC+ per category of derivatives, this amendment further complicates the regulation.

Another complication is Brexit, as the UK is no longer bound by EU regulations. To avoid chaos and confusion in the short term the UK adopted a sensible approach and simply copied EMIR, called it UK EMIR and enacted the regulation locally. However the UK did not leave the EU to just blindly continue to follow the EU rules. The country wants to become more competitive and already now the discussion has started about the impact on UK EMIR.

So what started out as a sensible, concerted effort to make the financial world financially safer on a global level is slowly drifting apart with countries going for solutions that suit their own situation perfectly and leaving the reconciliation of different regulatory regimes to those that have to implement them  – mostly banks. For example, a European bank with a UK presence (and who does not have at least a London Branch?) will have to cope with 2 different regulations, making implementation in shared service centres unduly complex and therewith increasing the chance of errors or omissions.

And it’s not over. Most recently, Europe/ESMA started its 2020 consultation round on technical standards for derivatives reporting. All these European officials have to keep themselves busy and will undoubtedly introduce changes to the regulation the coming year. The intention of the consultation round is to deliver better control or higher efficiency. One could be forgiven to be sceptical whether this will be the outcome.

The world would be better served if regulators could set aside their parochial perspectives and agree on one regulation, to be applied equally in all jurisdictions. The efficiency and clarity that this would give the market would benefit market participants in implementation cost and indirectly their clients (better pricing). Furthermore, better tooling can be developed as the market for suppliers becomes bigger.

The overall goal should be to follow the 80/20 rule. 80% of the result can be achieved with only 20% of the measures. From the banks’ perspective, the projects constantly follow each other or are competing for the same scarce human resources to have regulations implemented in time. The regulatory agenda is driving development, which is killing for real innovative developments.

That is probably why start-ups and fintech are doing it better. They are less bothered by regulators as they seem to swim just outside their scope or are being treated as young developing plant not to be disturbed ( e.g. Wirecard). Banks should get their act together and orchestrate their voice to the regulators or pro-actively come with alternatives to achieve the regulators’ objectives at lower complexity and cost. As usual, perfection is the enemy of progress.

Klaes Visser