How EMIR REFIT impacts your reporting requirements

Agreed Upon Procedures (“AUP”) become applicable when one of the following thresholds is exceeded by the NFC at least once at a month-end during the year:

• Number of over-the-counter (OTC) derivative contracts exceeds 100.
  
  
• Total notional value of OTC derivatives exceeds 100 million euros.

If either threshold is surpassed, the statutory auditor is required to prepare a long-form report to the regulator (“FSMA”) under the form of AUP. If the company has had no new or modified derivatives during the year, it may request an exemption from the FSMA to forego this extended report. The AUP report must be submitted within six months after the closing of the accounting year. Therefore, for most NFCs, the deadline is 30 June of the following year.

In addition, statutory auditors must comply with the so-called “alarm bell” procedure, which is mandatory for all NFCs, regardless of whether the aforementioned thresholds have been met. If the auditor identifies any instance of non-compliance with EMIR regulations (regardless of materiality), (s)he is obligated to inform the company’s management. Should the management fail to take appropriate measures to return to compliance with the EMIR regulation within three months, the auditor must then notify the FSMA. Conversely, if the FSMA detects an infringement themselves, they may question the statutory auditor as to why the issue was not reported to them, potentially leading to liability risks for the auditor.

Prior to the introduction of the first EMIR REFIT, on 18 June 2020, all companies engaging in derivative transactions were responsible for ensuring timely and accurate reporting of their derivatives to a trade repository. However, since then, an FC that is subject to EMIR (in that it is established in the EU) has become solely responsible and legally liable for reporting the details of OTC derivative contracts concluded with an NFC- on behalf of both counterparties. If the NFC- wishes to continue reporting these OTC derivative contracts itself, it may do so but must inform the FC accordingly (“opt-out”). This is however not very common, as the majority of NFC- rely on the FCs to perform the reporting. This reporting requirement extends beyond OTC derivatives, and also covers derivatives that are traded on a regulated market.

To ensure the FC has the data it needs to fulfill its reporting obligation, the NFC- must provide it with the details of the OTC derivative contracts concluded between them, which the FC cannot reasonably be expected to possess. This is usually done through the trade confirmations, which remain a requirement under EMIR REFIT (please refer to the section below).

If an NFC- concludes an OTC derivative contract with an entity established in a third country, the NFC- is not required to report that contract provided that:

• The third-country entity qualifies as an FC if it were established within the EU;
  
  
• The legal regime for reporting applicable to the third-country entity is declared equivalent under Article 13 of EMIR; and
  
  
• The third-country entity has reported the details of the OTC derivative contract pursuant to that third-country legal regime for reporting to a Trade Repository (TR) that is legally obligated to provide data access to the entities specified in Article 81(3) of EMIR.

If these conditions are not met, the NFC- remains legally liable for reporting to a trade repository. Currently, only a few third countries have obtained a formal equivalency for transaction reporting.

The first EMIR REFIT also introduced an intragroup exemption, so that derivative contracts within the same group, where at least one counterparty is a non-financial counterparty (or would be qualified as such if it were established in the Union), are exempt from the reporting obligation provided that the following conditions are met:

• Both counterparties are included in the same consolidation on an integral basis;
  
  
• Both counterparties are subject to appropriate centralized risk evaluation, measurement and control procedures; and
  
  
• The parent undertaking is not a financial counterparty.

NFCs intending to take advantage of this exemption must first notify their National Controlling Authority (NCA). The exemption will be valid unless the NCA disagrees with the fulfillment of the conditions for the exemption within three months of the notification date. It is important to note that this exemption must be obtained from all involved NCAs, not just in Belgium. So e.g. for a cross-border intercompany trade between a Belgian group entity and a French group entity, the request for exemption should be made to the Belgian NCA (i.e. the FSMA) and to the French NCA (i.e. the AMF).

With the implementation of the second EMIR REFIT, reporting to a trade repository has become more extensive and standardized. Reports must be filed using a common XML template, aligned with ISO 20022 standards, and must include UPIs and UTIs. Companies that continue to report their own derivatives (or a portion thereof) must adhere to the updated reporting template.

In the AUP, the auditor is required to investigate the company’s policies in respect of EMIR. The auditor must also verify the correct reporting to a trade repository, based on the population of the derivatives for which the company is responsible to report. This includes taking into account the obtained intragroup exemptions and the derivatives concluded with financial counterparties in third countries. Finally the auditor must also verify certain administrative elements, such as whether the company has a valid Legal Entity Identifier (‘LEI’) and whether contract documents are retained for at least 5 years.

Certain risk-mitigating activities must be in place for non-cleared derivatives. It is the company’s responsibility to Implement effective risk mitigation activities, along with the necessary processes and controls. Agreements on trade confirmation, portfolio reconciliation, portfolio compression and dispute resolution are typically found in the ISDA agreements (which can be done via an EMIR annex). The company may also formally adhere to the 2013 ISDA Protocol on Portfolio Reconciliation, Dispute Resolution and Disclosure on the ISDA website.

When performing the AUP, the auditor is required to investigate the company’s policies regarding these risk mitigation techniques. The auditor must also verify the timely confirmation of a selection of derivatives (within two working days), whether the portfolios have been reconciled on a timely basis (annually, or quarterly when there are more than 100 open positions with a particular counterparty) and whether any disputes have occurred.

Whether the company is classified as an NFC+ or NFC- is determined based on the clearing threshold calculation. If any of the clearing thresholds are breached, the company is classified as NFC+. Additionally, companies that do not calculate this clearing threshold get an automatic NFC+ classification. When calculating the clearing threshold, derivatives concluded for the purpose of hedging financial risks (e.g. interest, currency, commodity …) may be excluded. Therefore, most large corporates are considered NFC-.

Currently, the clearing thresholds are:

• EUR 1 billion in gross notional value for OTC credit derivative contracts
  
  
• EUR 1 billion in gross notional value for OTC equity derivative contracts
  
  
• EUR 3 billion in gross notional value for OTC interest rate derivative contracts
  
  
• EUR 3 billion in gross notional value for OTC foreign exchange derivative contracts
  
  
• EUR 4 billion in gross notional value for OTC commodity derivative contracts and other OTC derivative contracts not falling within categories A-D.

Should the company exceed one of these thresholds, it no longer qualifies as NFC-, resulting in additional requirements for the company. This also implies that the auditor must perform the Valuation part of the AUP.

Only OTC derivatives are included in the calculation of the clearing threshold. The definition of OTC derivatives is provided in Article 2 of the EMIR Regulation: ‘OTC derivative’ or ‘OTC derivative contract’ means a derivative contract for which the execution does not take place on a regulated market as within the meaning of Article 4(1)(14) of the MiFID Directive 2004/39/EC or on a third-country market considered as equivalent to a regulated market in accordance with Article 19(6) of that same Directive. This subject is also addressed in ESMA Q&A OTC Question 1.

Since hedging derivatives are excluded, and most NFCs conclude derivatives only for hedging purposes, the definition of hedging is important (ESMA Q&A OTC Question 10).

The definition of hedging for EMIR purposes is broader than the definition used in the IFRS accounting rules. Therefore, OTC derivative contracts that qualify as hedging under IFRS rules also qualify as hedging for EMIR purposes. Moreover, some OTC derivative contracts may qualify as hedging for EMIR purposes (which includes also proxy hedging and macro or portfolio hedging) although they do not qualify as hedging under the strict IFRS rules. The policies adopted by a counterparty, in particular when audited, provide an indication of the nature of the OTC derivative contracts, but this should be supported by an analysis of the contracts actually concluded.

Therefore, except where the OTC derivative contracts concluded by a counterparty qualify as hedging contracts under the IFRS rules, neither audited accounts nor internal policies alone are sufficient to demonstrate that the relevant contracts are for hedging purposes. This must be supplemented by evidence of the actual risk that the contract is hedging. In this respect, the company should be able to demonstrate that:

• The risk management systems prevent non-hedging transactions from being qualified as hedging solely on the grounds that they are part of a risk-reducing portfolio on an overall basis;
  
  
• Quantitative risk management systems should be complemented by qualitative statements in internal policies, defining a priori the types of OTC derivative contracts included in the hedging portfolios and the eligibility criteria, i.e. limited to covering risks directly related to commercial or treasury financing activities;
  
  
• The risk management systems provide a sufficiently disaggregated view of the hedging portfolios in order to establish the direct link between the portfolio of hedging transactions and the risks that this portfolio is hedging;
  
  
• When a group has NFCs established in different countries, and a central unit responsible for the risk management systems of several entities within the group, these systems should be used consistently across all the entities; and
  
  
• The risk management system should not be limited to a binary mechanism that classifies all OTC derivative transactions as hedging, up to a certain limit (e.g. a predefined risk metric reaches a predefined value in absolute or relative terms), and as non-hedging once this limit is exceeded.

In the AUP, the auditor is required to investigate the procedures to monitor the clearing threshold, including whether the calculation is performed at least on a monthly basis. The auditor must also give a description of the hedging policies/criteria and verify whether hedging derivatives qualify for one of the three hedging exclusion criteria defined in the EMIR regulation (hedging of value changes in assets/liabilities/services, hedging risk arising from interest rates, inflation, currency rates, credit risk… or application of IFRS hedge accounting).
 

How EY can help

If you have any questions, please reach out to our dedicated financial instruments and EMIR team, Jean-François Hubin and Geert Van Mol. Our team has acquired significant expertise through conducting dozens of AUP engagements annually, and by providing assistance to firms across all facets of EMIR. We offer a comprehensive multidisciplinary approach designed to help you navigate the complexities of EMIR and EMIR REFIT.