• ISDA Publishes EMIR Classification Letter
  • July 21, 2015 | Authors: Brian Barrett; Daphne G. Frydman; Catherine M. Krupka; David T. McIndoe; Mark D. Sherrill
  • Law Firms: Sutherland Asbill & Brennan LLP - New York Office ; Sutherland Asbill & Brennan LLP - Washington Office
  • On July 13, the International Swaps and Derivatives Association, Inc. (ISDA) published the ISDA EMIR Classification Letter (the Classification Letter), a form of letter that may be used by market participants managing their regulatory obligations under the European Market Infrastructure Regulation (EMIR). EMIR, the European Union’s (EU) derivatives reform regulation, classifies counterparties to derivatives trades as “financial counterparties” (FCs) or “non-financial counterparties” (NFCs), with the latter category further broken down into entities above a designated clearing threshold (NFC+) and those below it (NFC-). Among other requirements,1 EMIR mandates clearing of certain over-the-counter (OTC) derivatives transactions by FC and NFC+ entities. Clearing has not yet come into effect in the EU, though the rules have been proposed and are nearly finalized.2 An entity’s characteristics and group aggregate month-end average of outstanding gross notional amount of all OTC derivatives will determine which clearing category3 and which compliance date apply to that entity.

    The Classification Letter is one way to facilitate communication of classification status between counterparties to a derivatives transaction subject to EMIR. An entity providing the letter makes elections in Appendix I, “EMIR Clearing Categorization,” and/or Appendix II, “EMIR Counterparty Classification,” to provide the recipient(s) of the letter with status information. A party specifies in Appendix I its clearing classification (Category 1-4), whether it is an alternative investment fund or a pension scheme arrangement (and if so, whether an exemption for pension scheme arrangements provided under EMIR will be used).4 In Appendix II, a party specifies whether it is a third-country entity, whether it is out of scope for EMIR and, if so, in what capacity,5 its EMIR entity classification (FC or NFC), its clearing threshold, and whether it is a pension scheme arrangement availing itself of the exemption. Parties will make elections in one or both appendices depending on their specific circumstances.

    Note that ISDA has published other vehicles for EMIR classification in the recent past, including the ISDA 2013 EMIR NFC Representation Protocol, the EMIR Counterparty Classification Tool and the EMIR Clearing Classification Tool.6 Market participants continue to have these options at their disposal, and each is effective for purposes of communicating classification under EMIR. However, note that the NFC Representation Protocol does not get into specifics regarding a party’s clearing category. The Classification Letter purposefully was developed to allow parties that do not use ISDA Amend to have the option of communicating their classification efficiently to their derivatives counterparties. To the extent that ISDA Amend was previously used, the Classification Letter provides the ability to designate which set of EMIR classification representations should govern. In addition, footnotes to the Classification Letter make clear that market participants can elect to use the content of the letter to communicate with counterparties in other formats, such as inclusion in the body of an e-mail.

    The Classification Letter can be accessed on ISDA’s website at http://www2.isda.org/emir/ by clicking on the “ISDA EMIR Classification Letter” link.

    1 EMIR also requires, generally, mitigation of risks associated with uncleared OTC derivatives, and reporting of derivatives transactions to trade repositories.

    2 See Sutherland’s February 2015 Legal Alert, Mandatory Clearing in Europe May Still Be “A Ways Off.”
    3 The clearing categories as proposed are as follows: “Category 1” includes an entity that, on the date of entry into force of the clearing rules, is a clearing member, for at least one of the classes of OTC derivatives subject to the clearing obligation of at least one of the clearinghouses authorized or recognized before that date to clear at least one of those classes. “Category 2” includes an entity that (a) is not a Category 1 entity, (b) belongs to a group whose aggregate month-end average of outstanding gross notional amount of non-centrally cleared derivatives (including foreign exchange forwards, swaps and currency swaps) is above EUR 8 billion, and (c) which is an FC or an alternative investment fund that is an NFC+. “Category 3” includes an entity that is not a Category 1 or 2 entity, and that is an FC or an alternative investment fund that is an NFC+. “Category 4” includes an NFC+ entity that is not a Category 1, 2 or 3 entity.
    4 The latter two questions do not apply to “third country entities” (i.e., countries not part of the European Economic Area or otherwise subject to EMIR).
    5 Certain EU entities are out of scope under EMIR for all or some of the EMIR provisions pursuant to Article 1 of EMIR: (a) members of the European System of Central Banks and other EU member states’ bodies performing similar functions and other EU public bodies charged with or intervening in the management of public debt; (b) the Bank for International Settlements, (c) multilateral development banks, as listed under Section 4.2 of Part 1 of Annex VI to EU Directive 2006/48/EC; (d) public sector entities within the meaning of point (18) of Article 4 of EU Directive 2006/48/EC where they are owned by central governments and have explicit guarantee arrangements provided by central governments; and (e) the European Financial Stability Facility and the European Stability Mechanism.
    6 Both the EMIR Counterparty Classification Tool and the EMIR Clearing Classification Tool are available to market participants on ISDA Amend at http://www.markit.com/product/isda-amend.