The European Securities and Markets Authority (ESMA) has written to the European Commission seeking clarification of the term “derivatives” as it is understood under the European Market Infrastructure Regulation (EMIR), according to Morgan, Lewis & Bockius partner William Yonge.
The securities authority is concerned that the term is not understood in exactly the same way across the European Union, which could lead to problems with how the EMIR scheme is applied. With regard to EMIR, “derivatives” means any of the financial instruments set out in Annex I of the Markets in Financial Instruments Directive (MiFID) [PDF]. These include transferable securities, money-market instruments and derivative instruments for the transfer of credit risk.
The MiFID is transposed into local law across EU states in different ways, Yonge writes, meaning that there is no universal definition of what constitutes a “derivative” in the EU. This makes it impossible to apply the EMIR EU-wide and essentially defeats the point of an EU regulation, he notes.
The EMIR’s primary objective is to regulate derivatives transactions, so this confusion could create an uneven playing field for market participants, Yonge writes. For example, under the EMIR, margin requirements are higher for over-the-counter derivatives than for other types of financial instruments, so a central counterparty in one member state might face higher margin requirements than those called for in a different state.
Additionally the clearing obligations and the risk mitigating obligations would not apply uniformly EU-wide, which would conflict with EMIR’s objectives. The ESMA is urgently seeking clarification on how the commission would define currency derivatives in relation to both spot and forward trades and with regard to their conclusion for commercial purposes, as well as with regard to commodity forwards that can be physically settled, Yonge writes.