EMIR 3: Provisional Request on Fee Determination

The European Market Infrastructure Regulation (EMIR) has been a cornerstone of financial regulation within the European Union (EU) since its inception, playing a pivotal role in enhancing transparency and reducing systemic risk in the over-the-counter (OTC) derivatives market. As global financial markets evolve, the regulatory frameworks that govern them must also adapt to address emerging challenges and risks. The latest iteration, EMIR 3, marks a significant regulatory advancement, particularly in its focus on mitigating risks associated with third-country central counterparties (CCPs) and improving the efficiency, stability, and resilience of EU clearing markets.

In July 2024, the European Banking Authority (EBA) received a provisional request from the European Commission for technical advice regarding the determination of fees and the modalities of payment related to the validation of pro-forma models under EMIR 3. This section delves into the technical and regulatory implications of this request, providing a detailed analysis of its context, scope, and potential impact on market participants.

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EMIR 3 : emergency collateral requirements

The latest EMIR 3 amendment, effective from 2024, brings significant changes to the EU’s financial regulatory framework. Key updates include the eligibility of uncollateralized public guarantees and permanent liquidity support measures.

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EMIR 3.0: Key Changes for Derivative End-Users

Discover the latest changes in EMIR 3.0, recently approved by the European Parliament. Stay informed on key updates affecting derivative end-users for seamless adaptation to the evolving regulatory landscape.

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Background and Context of EMIR 3

The EMIR framework was initially established to increase transparency in the derivatives market, reduce counterparty credit risk, and mitigate systemic risk. Over time, as financial markets have become more interconnected and complex, particularly with the growing involvement of third-country CCPs, the need for enhanced regulatory measures has become evident. EMIR 3 is a response to these evolving challenges, aiming to fortify the EU’s clearing infrastructure and reduce its reliance on non-EU CCPs, which could pose significant risks to the EU’s financial stability.

Scope and Purpose of EMIR 3

On 7 December 2022, the European Commission proposed substantial amendments to the existing EMIR framework, collectively known as EMIR 3. These amendments were designed to address specific vulnerabilities and inefficiencies in the EU’s clearing markets, particularly the over-reliance on third-country CCPs, which can expose the EU to systemic risks beyond its regulatory reach. The political agreement on these amendments was reached by the European Parliament and the Council by early 2024, with formal endorsements following in March 2024. The revised regulation is expected to be published in the EU Official Journal by Q4 2024, with the provisions set to enter into force twenty days after publication.

The primary objectives of EMIR 3 are to:

1. Enhance the Attractiveness of EU Clearing Services: By making EU-based CCPs more competitive and appealing to market participants, EMIR 3 aims to build liquidity within the EU. This objective is critical in reducing the EU’s dependency on systemic CCPs located outside its jurisdiction, which are not subject to the same level of oversight by EU regulators.
2. Strengthen Financial Stability: EMIR 3 introduces measures that contribute to a more robust financial system by ensuring that market participants are incentivized to use EU-based CCPs. This reduces the systemic risks that could arise from the potential failure or disruption of third-country CCPs, which might not fully align with EU regulatory standards.
3. Support the Capital Markets Union (CMU): The amendments align with the broader goals of the CMU, which seeks to create a single market for capital in the EU. By improving the efficiency and resilience of clearing markets, EMIR 3 plays a crucial role in fostering a well-functioning CMU.
4. Enhance Supervisory Oversight: EMIR 3 significantly strengthens the role of the European Securities and Markets Authority (ESMA) in supervising CCPs. This enhanced oversight is informed by lessons learned from recent market events, ensuring that the EU’s regulatory framework is equipped to handle future challenges.

EMIR III: The Commission's Provisional Request for Technical Advice

As part of the ongoing implementation of EMIR 3, the European Commission issued a provisional mandate to the EBA on 31 July 2024. This mandate requests the EBA to provide technical advice on a possible delegated act that would specify the method for determining fees payable by financial and non-financial counterparties for the validation of pro-forma models. Additionally, the EBA is tasked with advising on the modalities of payment for these fees, including the frequency of payments, the structure, and any penalties for late payments.

Technical and Regulatory Implications

The Commission’s request is a critical step in operationalising EMIR 3, as it addresses the practical aspects of how fees related to model validation will be structured and implemented. These fees are essential for ensuring that the EBA has the necessary resources to carry out its expanded role under EMIR 3, particularly in validating the models used by counterparties to calculate initial margin requirements for non-centrally cleared OTC derivatives.

The request underscores several key regulatory considerations:

1. Transparency in Fee Determination: The Commission emphasises the need for a clear, transparent methodology in determining the fees that counterparties must pay. This transparency is crucial not only for ensuring fairness but also for maintaining trust in the regulatory process. By providing a well-defined structure, the EBA can help prevent any arbitrary or disproportionate fee impositions that could burden smaller market participants.
2. Proportionality of Fees: The fee structure must be proportional to the scale and complexity of the counterparties’ activities. Specifically, the fees should reflect the monthly average outstanding notional amount of non-centrally cleared OTC derivatives over the last 12 months. This approach ensures that larger counterparties, which engage in more extensive trading activities, contribute a fairer share of the costs associated with model validation.
3. Modality of Payment: The Commission has also requested the EBA to consider the modalities of payment, which include not only the timing and frequency of payments but also the mechanisms for collecting these fees in a manner that is both efficient and predictable. This is particularly important for ensuring that the fee structure does not introduce additional operational complexities or financial burdens that could hinder market participation.
4. Alignment with Broader Regulatory Goals: The EBA’s advice must align with the broader regulatory objectives of EMIR 3, ensuring that the fee structure supports the overarching goals of enhancing financial stability, fostering market liquidity, and reducing systemic risk. This alignment is critical for the seamless integration of the fee determination process within the existing regulatory framework.

Impact on Market Participants

The introduction of fees for the validation of pro-forma models under EMIR 3 has significant implications for market participants. For financial and non-financial counterparties, these fees represent an additional compliance cost that must be carefully managed. The proportional nature of the fees is intended to mitigate the financial impact on smaller market participants; however, the administrative burden of ensuring timely and accurate payment could still pose challenges, particularly for firms with limited resources.

Moreover, the emphasis on a rigorous and transparent model validation process reinforces the importance of robust risk management practices. Market participants must ensure that their internal models are not only compliant with EMIR 3 requirements but also resilient to the scrutiny of the EBA’s validation processes. This could necessitate additional investments in risk management infrastructure, particularly for counterparties that are heavily reliant on complex derivative strategies.

Technical Advice on EMIR 3

In anticipation of the formal adoption of EMIR 3, the European Commission took a critical step on 31 July 2024, by issuing a provisional mandate to the European Banking Authority (EBA). This mandate requests detailed technical advice on the formulation of a possible delegated act, focusing specifically on the determination of fees payable by financial and non-financial counterparties that require the validation of pro-forma models under EMIR 3. Additionally, the EBA is tasked with advising on the modalities of payment for these fees, ensuring that the structure is both fair and functional within the broader regulatory framework.

Delegated Act Under Article 290 TFEU

The delegated act that the European Commission seeks to adopt falls under the provisions of Article 290 of the Treaty on the Functioning of the European Union (TFEU). Article 290 TFEU grants the Commission the authority to supplement or amend certain non-essential elements of legislative acts through delegated acts, which are subject to review and possible objection by the European Parliament and the Council. This mechanism is crucial in allowing the Commission to adapt and refine legislative measures in response to evolving market conditions and regulatory needs.

The provisional nature of the mandate reflects the fact that EMIR 3 has not yet entered into force, but the Commission is proactively preparing for its implementation. This forward-looking approach is essential in ensuring that the necessary regulatory infrastructure is in place as soon as EMIR 3 becomes law. The Commission's proactive stance highlights the importance of timely and effective regulation in maintaining the stability and resilience of the EU’s financial markets.

Procedures

To ensure that the delegated act is well-informed and robust, the European Commission has outlined a formal procedure for requesting technical advice from the EBA. This procedure is deeply rooted in several key regulatory and legal frameworks, which together form the foundation for the EBA’s role in this process:

1. EMIR (Article 82): This article provides the legal basis for the Commission’s powers to adopt delegated acts in relation to EMIR. It underscores the importance of ensuring that any amendments or supplements to the regulation are consistent with the overarching goals of transparency, stability, and risk mitigation in the derivatives market.
2. EBA Regulation: The European Banking Authority operates under its own regulation, which defines its responsibilities, including the provision of technical advice to the European Commission. The EBA’s role in advising on the delegated act is a direct extension of its mandate to oversee and ensure the integrity of the EU’s banking sector, particularly in relation to systemic risk and market stability.
3. 290 Communication: This refers to the European Commission’s communication on the implementation of Article 290 TFEU, which outlines the processes and principles governing the adoption of delegated acts. The communication ensures that the Commission’s actions are transparent, accountable, and in line with the expectations of the EU’s legislative bodies.
4. Framework Agreement: The Framework Agreement establishes the working relationship between the European Parliament and the European Commission, particularly concerning the adoption of delegated acts. This agreement ensures that the Parliament is adequately informed and involved in the process, thereby providing an additional layer of oversight and democratic legitimacy.

The EBA’s Role in Providing Technical Advice

The European Commission’s request places significant responsibility on the EBA, entrusting it with the task of developing a fee structure that is both equitable and effective in the context of EMIR 3. The EBA’s advice will be instrumental in shaping the final delegated act, which will have a profound impact on how financial and non-financial counterparties operate within the framework of EMIR 3.

Key Responsibilities of the EBA

1. Determination of Fees: A central aspect of the EBA’s mandate is to determine the appropriate fees to be charged for the validation of pro-forma models. These models are critical for the calculation of initial margins on non-centrally cleared OTC derivatives, and their validation is a key component of ensuring that market participants manage their risks effectively. The EBA must ensure that the fee structure is proportionate to the scale of activities of the counterparties involved. Specifically, the fees should be aligned with the monthly average outstanding notional amount of non-centrally cleared OTC derivatives over the past 12 months. This proportional approach ensures that larger counterparties, with more significant market activities, contribute a fairer share of the costs associated with the validation process.
2. Modalities of Payment: In addition to determining the fee amounts, the EBA is also tasked with advising on the modalities of payment. This includes establishing the frequency of payments (e.g., annual, quarterly), the potential for implementing payment schedules, and mechanisms for handling late payments. The goal is to create a payment system that is efficient, predictable, and minimizes administrative burdens on counterparties. Moreover, the EBA must ensure that the payment process is transparent and that all counterparties are treated equitably, with clear guidelines on how fees are assessed and collected.

Principles Guiding the EBA’s Technical Advice on the European Market Infrastructure Regulation

As part of the European Commission’s provisional request for technical advice on EMIR 3, the European Banking Authority (EBA) has been guided by a set of principles designed to ensure that the advice it provides is aligned with the overarching goals of the regulation. These principles are critical in shaping the structure and implementation of fees associated with the validation of pro-forma models under EMIR 3, and they provide a framework for how the EBA should approach this complex task.

Proportionality

One of the cornerstone principles guiding the EBA's technical advice is proportionality. The principle of proportionality is essential in ensuring that the regulatory measures proposed do not impose unnecessary burdens on financial and non-financial counterparties. Specifically, the EBA must ensure that the fee structure is straightforward, equitable, and does not exceed what is necessary to achieve the regulatory objectives of EMIR 3.

In practical terms, this means that the fees should be scaled according to the size and complexity of the counterparties’ activities. For instance, a smaller counterparty with lower trading volumes in non-centrally cleared OTC derivatives should not be subjected to the same fee levels as a large financial institution with substantial trading activity. The EBA must therefore design a fee structure that accurately reflects the scale of each counterparty's operations, ensuring that larger entities, which pose a greater systemic risk, contribute a proportionately higher share of the fees. This approach prevents disproportionate financial strain on smaller market participants while maintaining the integrity and effectiveness of the regulatory framework.

Coherence and Consistency

Another critical principle is coherence and consistency within the broader EU regulatory framework. The EBA must ensure that its advice aligns with existing delegated regulations on fees from European Supervisory Authorities (ESAs), particularly in light of recent harmonization efforts. For example, the Commission Delegated Regulation (EU) 2024/1704 on fees from trade repositories serves as a relevant precedent, and the EBA’s recommendations must be consistent with such regulations to maintain regulatory harmony across different sectors of the financial market.

Flexibility in Reflection

While the EBA is focused on the specific elements required for the delegated act, the principle of flexibility in reflection encourages the EBA to go beyond the immediate mandate if necessary. The EBA is encouraged to consider broader implications and provide guidelines or recommendations that might not be strictly within the scope of the delegated act but could enhance its effectiveness.

For instance, if the EBA identifies potential areas where additional regulatory clarity could improve the implementation of EMIR 3, it should not hesitate to make such recommendations. This proactive approach ensures that the delegated act is not only fit for purpose but also adaptable to future developments in the financial markets.

Cross-Sectoral Consistency

Cross-sectoral consistency is another guiding principle, particularly important given the interconnected nature of financial markets. The EBA must collaborate with other regulatory bodies, such as the European Securities and Markets Authority (ESMA) and the Single Supervisory Mechanism (SSM), to ensure that the fee structures and regulatory approaches are consistent across different sectors.

Consultation and Transparency

The principle of consultation and transparency is fundamental to the legitimacy and effectiveness of the EBA’s technical advice. The EBA is expected to engage in an open and transparent consultation process with a wide range of market participants, including financial institutions, industry bodies, and other stakeholders. This consultation process ensures that the EBA’s advice is informed by the practical realities of the market and reflects the concerns and insights of those who will be directly affected by the new regulations.

Quantitative and Qualitative Analysis

A thorough quantitative and qualitative analysis is also a key requirement in the EBA’s advisory process. This analysis must encompass a detailed cost-benefit assessment of all options considered. By providing both quantitative data, such as cost estimates and potential economic impacts, and qualitative insights, such as stakeholder opinions and regulatory effectiveness, the EBA can ensure that its recommendations are well-rounded and robust.

The cost-benefit analysis should not only justify the EBA’s choices but also provide a clear comparison of the different options available, highlighting the trade-offs and potential outcomes of each. This rigorous analytical approach is essential for ensuring that the final fee structure under EMIR 3 is both economically viable and aligned with the broader goals of financial stability and market efficiency.

Clear and Structured Advice

Finally, the principle of clear and structured advice emphasises the need for the EBA’s recommendations to be presented in a manner that is easily understandable and accessible to all stakeholders. The advice should be free of unnecessary legal jargon and should respect current EU terminology, making it straightforward for market participants, regulators, and policymakers to interpret and implement.

This clarity is particularly important in the complex and often technical field of financial regulation, where misunderstandings or ambiguities can lead to significant compliance challenges or unintended regulatory consequences. By providing clear, structured advice, the EBA ensures that the regulatory framework under EMIR 3 is implemented smoothly and effectively, with minimal confusion or disruption to the market.

European Market Infrastructure Regulation: Implications of the Provisional Request

The principles guiding the EBA’s technical advice on fee determination under EMIR 3 carry significant implications for both market participants and regulators:

1. Enhanced Oversight and Compliance: The establishment of a formal fee structure underscores the EU’s commitment to rigorous oversight and compliance within the derivatives market. This structure is likely to increase the administrative burden on counterparties, particularly in ensuring that their risk models meet the stringent validation requirements set by the EBA. However, this is balanced by the proportional approach, which aims to distribute the costs in a fair manner according to the scale of each entity's market activity.
2. Increased Costs for Market Participants: The introduction of these fees, while necessary for covering the costs of model validation, will represent an additional financial burden, especially for smaller counterparties. These entities may need to reassess their participation in non-centrally cleared OTC derivatives markets, considering the potential impact on their operational costs.
3. Clarity and Predictability: The EBA’s structured and transparent approach to fee determination will provide much-needed clarity and predictability for market participants. With a clear understanding of the fee structure and payment modalities, firms can better plan for and manage these costs, reducing the risk of unexpected financial burdens that could disrupt their operations.
4. Strengthened Financial Stability: By ensuring that all pro-forma models used in the market are thoroughly validated and compliant with EMIR 3 requirements, the EBA’s advice will contribute to a more stable and resilient financial system. This is particularly important in mitigating systemic risks associated with non-centrally cleared derivatives, which have the potential to impact the broader financial ecosystem.

Indicative Timetable and Urgency in Implementing EMIR 3

The implementation of EMIR 3 is a critical priority for the European Commission, reflecting the need to enhance the resilience and stability of the EU's financial markets in a timely manner. Recognizing the importance of this regulatory update, the Commission has set a stringent timeline for the European Banking Authority (EBA) to deliver its technical advice on the fee structure and payment modalities for the validation of pro-forma models. This timeline underscores the urgency of operationalizing the amended EMIR regulation to address the evolving risks in the derivatives market.

Clear Timeline for Technical Advice Delivery

The Commission has established a clear and rigorous deadline for the EBA to submit its technical advice, set for Q2 2025. This deadline aligns with the broader schedule for adopting the delegated act under Article 290 of the Treaty on the Functioning of the European Union (TFEU). The specified timeframe reflects the Commission's commitment to ensuring that the regulatory framework under EMIR 3 is implemented swiftly and effectively, minimising any gaps in oversight that could arise during the transition to the new regime.

The urgency associated with this timeline is driven by the critical role that EMIR 3 plays in strengthening the EU's financial system, particularly in mitigating the risks posed by third-country central counterparties (CCPs) and enhancing the robustness of EU-based clearing services. The timely submission of the EBA’s advice is essential to maintaining the momentum of the regulatory process, ensuring that all necessary measures are in place to support the full implementation of EMIR 3.

Article 290 TFEU and the Delegated Act Process

The process for adopting the delegated act that will define the fee structure under EMIR 3 is governed by Article 290 TFEU. This article provides the legal framework for the European Commission to adopt delegated acts, which are non-legislative acts intended to supplement or amend certain non-essential elements of legislation. The delegated act process includes several key steps to ensure that the act is thoroughly reviewed and that it meets the necessary legal and regulatory standards.

Under Article 290 TFEU, once the delegated act is adopted by the Commission, it is submitted to the European Parliament and the Council for review. These institutions have a period of three months to examine the act and raise any objections. This review period is a critical phase in the legislative process, as it allows for a thorough examination of the proposed measures, ensuring that they are aligned with the EU's broader regulatory objectives. The review period can be extended by an additional three months, providing ample time for scrutiny and any necessary adjustments.

The delegated act will only enter into force if neither the European Parliament nor the Council objects within the stipulated review period. Alternatively, the act can be enacted sooner if both institutions formally inform the Commission that they do not intend to raise objections. This process ensures a balanced approach to regulation, where the Commission's technical expertise is complemented by the oversight and democratic scrutiny of the EU's legislative bodies.