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Risk mitigation techniques for bilateral OTC derivatives under EMIR

The European Market Infrastructure Regulation (EMIR) came into effect on 16 August 2012. Besides the introduction of clearing and reporting obligations for OTC derivatives, the regulation also specifies increased requirements for risk mitigation procedures for bilateral OTC derivative transactions. These risk-mitigating measures are to be applied for all OTC derivative transactions not cleared through a central counter party (CCP), and relate to the following points:

 

Daily assessment

  • A mark-to-market assessment must be carried out on all bilateral OTC derivative contracts on a daily basis. A mark-to-model assessment is permitted only under specific conditions.  This requirement shall not be applicable for non-financial counterparties under the clearing threshold.

Timely confirmation

  • Specific confirmation periods need to be adhered to for all OTC derivative contracts that are not cleared. Confirmation should be made electronically as far as possible. For financial counterparties, the period for timely confirmation following a transition period is one day.

Regular portfolio adjustment

  • Regular portfolio adjustments need to be made in order to match all non-central OTC transactions that are not cleared with their respective contracting party. The frequency of adjustment (daily, weekly, quarterly) shall be determined on the basis of the size of the contracting party’s portfolio.

Dispute processes

  • Processes for identifying, clarifying, monitoring and documenting disputes (e.g. from margining, transaction assessment or in case of adjustment of transaction data) need to be defined and implemented.

Portfolio compression

  • If the portfolio size exceeds 500 transactions, the necessity of portfolio compression must be checked and, if necessary, carried out regularly and at least twice a year.

Bilateral collateralisation

  • The exchange of variation and initial margin is obligatory for bilateral OTC derivative contracts. The requirements for exchanging variation margin are likely to come into effect from 2015. The initial margin requirements should be introduced in stages within a transition period ranging from 2015 to 2019. This requirement shall not be applicable for non-financial counterparties under the clearing threshold.

 

The challenge during the implementation of risk-mitigating measures is that besides the number of specialised, process-related and technical aspects, the latest version of the legal specifications also needs to be constantly taken into account.

 

The key points of an implementation are:

  • Analysis of portfolios and existing internal processes
  • Determination of a requirement for implementation and adjustment
  • Conceptualisation and implementation of necessary adjustments in the IT infrastructure
  • Definition and introduction of suitable internal processes and checks as well as clarification of responsibilities.