by François Masquelier, Head of Corporate Finance and Treasury, RTL Group, and Honorary Chairman, European Association of Corporate Treasurers
One year has now elapsed since the laboured (but not postponed) launch of the new regulations on over-the-counter (OTC) derivatives, that famous regulation known as EMIR. Where do we stand with it now, on its first anniversary? Success or failure? What more might we expect from EMIR and from a possible review of this regulation? The question now is to decide whether we should be talking about an anniversary celebration or a wake. We think it worthwhile making an initial assessment to take stock of the current state of play and the work still to be done to fine-tune it.
‘Oh rage! Oh despair! Oh age, my enemy!’ (Corneille – Le Cid)
One year after EMIR, the over-the-counter derivatives regulation, was introduced, can we reasonably say that systemic risk has disappeared, or has at least been substantially reduced? Does EMIR provide a ‘plus’ to corporate treasurers, or is it just another hassle on top of all the others? In short, should we be laughing or crying? Rage or despair? Is it regulatory rage, a failed attempt or the beginnings of a solution? There are still plenty of things to do, even though in the final analysis EMIR will perhaps not be the universal panacea that its promoter, the European Commission, claims it to be. However, neither could we say that EMIR was not a well-intentioned measure. We were not happy with the way it was introduced and some of the obligations of this regulation do not suit us. Its reporting seems to us to be very cumbersome, and there seems no point in reporting inter-company transactions.
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EACT’s vigorous lobbying avoided compulsory clearing and managed to win relatively high thresholds that we can live with easily. In practice, and because of Basel III and bank segregation legislation, it may be that all non-financial companies will be forced to use collateral. The dispensation will then become purely hypothetical. We cannot rule out this risk since the idea keeps cropping up regularly. Even if legislation does not require it, perhaps it will be imposed in practice simply by the differential in the price with collateral and without collateral. The battle was won, but the war is far from over, I fear.
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The state of play
What is still to be done on this immense and complex task upon which Commissioner Barnier and his officials have embarked? The regulation needs to be modified further for the adjustments proposed by ESMA. The Q&As keep on bringing in clarifications here and there. Perhaps the birthday present might be an EMIR II for 2015 or even 2016. We shall see if the Commission plans to make more substantial amendments to its regulation (i.e., EU # 648/2012); hoping that if this is the case, the second episode will be better than the first.
The last Consultation Paper issued by ESMA (for which the response deadline was 13/02/2015) focused on the review of technical reporting standards under article 9 of EMIR. Article 9 requires ESMA to produce a draft Regulatory Technical Standard (RTS) and a draft Implementing Technical Standard (ITS) in connection with applying the counterparties and CCPs (clearing houses) reporting obligation. The aim was to raise the quality of the EMIR-related rules and improve them as much as possible. On the content, ESMA has already tried to improve and clarify the rules by means of the Questions & Answers (Q&As) that it publishes regularly. The goal is now to incorporate these improvements and clarifications, with other new material, into the Technical Standards.
ESMA’s final report will go before the European Commission, which will then have three months to endorse the standards before they finally become universally applicable. For example, we hope to have clearer pointers on how to fill in the mandatory fields in the reports, how to populate them in a consistent fashion, specifying in greater detail what each field should ideally contain. The idea is also to get rid of certain inconsistencies, and to clarify how mark-to-market valuations should be calculated, amongst other things. Nevertheless, we should give ESMA credit for trying to answer the outstanding questions and giving people the chance of commenting on its proposals. No longer, unfortunately, can anyone dispute the complexity of these documents and of the problems being addressed. You need to be an expert steeped in the detail to know where you are with this jumble of rules and fields. There is nothing simple about it unless you have the time to delve into these super-technical questions. We need to bear in mind that the final objective is to improve how EMIR works, even if that may not always simplify it.
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Problems as yet unsolved
Amongst the unanswered or pending questions, we would like to mention those that, in our opinion, constitute the main challenges in the day-to-day work of treasurers.
In this list of outstanding points, we can expound at length on one or two that deserve further attention. We hear the same old refrain coming up time and time again, “What are they going to do with all this data they have gathered?”. We have absolutely no idea. Are they actually capable of analysing this data? We very much doubt it. But we don’t think that they will give any ground on inter-company transactions, unfortunately. In spite of all the many efforts, they seem to be intransigent and immovable when it comes to withdrawing them. The repeated changes of format and the addition of reporting fields make the treasurer’s job much more difficult. The changes of 1 December 2014 forced many treasurers to revise their versions before their TRs (Trade Repositories) would accept their daily reports. The matter of penalties is still very much up in the air and varies from country to country, because these penalties are decided on locally and applied by National Supervisors. There will be a big reputational risk for the first one to be caught. ‘Back-loading’ the whole lot is still feasible. However, it would seem that many treasurers have decided to forget about back-loading (for which a three-year window has been granted) until further notice. They think, perhaps naïvely, that ESMA will prove lenient.
Reconciliations, when not done by third parties such as Tri-Optima, are complicated, even on spreadsheets since the formats vary so much through time and from bank to bank. The exercise is often manual, time-consuming and tiresome. Using a subcontractor is a must, even though it incurs a cost. IT systems, too, are a bit behind the curve and need to be modified to meet the new requirements. Suppliers’ reaction times are often disappointing in practice. We should not forget that LEIs (Legal Entity Identifiers) need to be renewed. This brings with it a not insignificant annual cost. In my view, the reports that can be produced by the systems and solutions offered by the TRs are still embryonic and disappointing. This is an area in which we may hope for significant improvements in the next few months. Another issue concerns how compliance with EMIR should be disclosed in the annual report. Perhaps the process should be reviewed by the external auditors or even the in-house compliance officer. Regular reconciliations might also make it easier to obtain or replace year-end FX audit confirmations. In the future, perhaps we would even be able to exchange reconciliation reports by means of ‘eBAM’ type SWIFT messages. Or is that just a pipe dream? Yes, probably, but it is still a possibility in the fullness of time.
‘Lost in transactions’
This compliance exercise is still tricky. Furthermore, over time, who can say that it will not have consequences for treasurers’ relations with banks? It will spur them to rationalise these relations to simplify reporting and avoid having a whole host of counterparties. Each new counterparty brings with it a further risk of errors. The combination of all these new regulations could have impacts that nobody suspects and nobody has quantified. The juxtaposition of rules could have consequences that were not suspected at the time they were laid down individually.
However, in spite of the existence of the exemption for collateral and clearing (subject to staying within the limits set out in EMIR) we cannot be sure it will apply in practice. Other regulations revisit this point regularly or try to force automatic clearing for transactions. And if regulation does not do it, unfortunately the market itself may force it on us, through the use of CSA-type agreements (i.e., bilateral agreements between banks and companies). To sum up, there are no guarantees that the market itself will not impose the very thing we wish to avoid. And if that does not happen, unilaterally posting collateral with your bank, when your portfolio has a negative mark-to-market value, will always be a way of significantly reducing the cost of hedging with financial instruments. With almost zero rates of interest in the Eurozone, why not use your cash surplus for this particular purpose? That would be a smart way of reducing your hedging costs.
In the final analysis, I believe that nobody currently knows how many of the population of non-financial corporations caught by EMIR comply with it. I would not bet on the number being large. Many, judging by the number of LEIs issued, are nowhere near it. The information coming from banks has perhaps subsided a bit.[[[PAGE]]]
‘Fly EMIRates’
We can only hope everyone has a good flight with EMIR, and wish them good luck in continuing to refine the mechanism – those, that is, who do not use third-party subcontractors – so that they keep on complying with this ever-changing regulation. The reconciliation process, for those who do it themselves, is neither simple nor finally settled. The TR reporting fields could still change. There is a clear risk of EMIR going off the boil. Interest in it seems to have fallen off a bit, although things are still moving, unfortunately. We are all rather sick and tired of all this compliance. However, this is only the start – the EMIR file will have to be reopened in the future. The risk of incurring a penalty or having your reputation blemished is enormous. The financial deterrent is relatively minor compared to the reputational risk in cases of non-compliance. The first one to be caught will never hear the last of it, that’s for sure.
We may expect a few marginal adjustments to the standard, but nothing fundamental, unfortunately. The inter-company transactions report will stay. Similarly, we will probably see new reporting fields being added, without others being taken away. This will continue to make report production more difficult, and will force us to modify systems and IT tools. The European Association of Corporate Treasurers (EACT), however, will keep on fighting to win the binding changes for which everyone is clamouring. By contrast, we would be hoping for far too much if we thought that ESMA might give us an outline of the quantified results of the reporting system, allowing us a broad overview. Nobody knows what ESMA currently does with the data, if anything, or if the game is in fact worth the candle. “What a load of nonsense!” treasurers will think. We are the victims, the collateral damage, of the excesses of the past on the derivatives markets.
Unfortunately, this first anniversary is not the end of the story. I fear that we will be coming back to revisit the matter of EMIR in the future. “May the force be with you” (Ihoda - Star Wars).
