When are FX Transactions subject to EMIR?
Since the introduction of the European Market Infrastructure Regulation (EMIR) there has been uncertainty as to whether an FX forward is subject to EMIR.
Central bank guidance
EMIR defines FX derivatives by reference to MiFID(1). In its guidance (published in the context of the reporting obligations which apply under EMIR), the Central Bank of Ireland provides that, as a temporary measure, FX forwards which settle between T+3 and T+7 are generally not required to be reported for EMIR purposes. The Central Bank indicated that it would revise this guidance depending on the approach taken by the European Commission in any relevant delegated regulation under MiFID II(2).
Commission delegated regulation
The Commission has adopted a Delegated Regulation which provides that spot FX is generally limited to transactions which settle in T+2 or less. Once it is published in the Official Journal, the Delegated Regulation will apply from the same date as MiFID II (3 January 2018).
Effect of the delegated regulation
From 3 January 2018 and with only limited exceptions (applicable to minor
currencies and to situations where settlement is in connection with a sale or purchase of securities), FX transactions which settle T+3 or over (Relevant FX Transactions) will constitute FX forwards for EMIR purposes.
In addition to being reportable, Relevant FX Transactions will be subject to the other EMIR requirements (including the requirements in relation to mandatory margining).
To date, the Central Bank has not updated its guidance to take account of the Delegated Regulation. However, the possibility of the Central Bank requiring a change in approach prior to the application of MiFID II on 3 January 2018 cannot be excluded.
Rolling spot FX contracts are derivatives
Separately, the Commission has confirmed that “rolling spot FX” are MiFID I derivatives (and accordingly are derivatives for the purposes of EMIR). In its Q&A, the Commission states that:
“As opposed to spot trading where there is immediate delivery, a rolling spot FX contract can be indefinitely renewed and no currency is actually delivered until a party affirmatively closes out its position. This exposes both parties to fluctuations in the underlying currencies…Hence rolling spot foreign exchange contracts are a type of derivative contract (i.e. either a forward or a financial contract for difference) relating to currencies and are considered financial instruments as defined under MiFID”.
The Delegated Regulation goes on to say that a contract shall not be considered a spot FX contract (and so shall be an FX derivative) if irrespective of its explicit terms) there is an understanding between the parties to the contract that delivery of the underlying is to be postponed and not to be performed within T+2 (or the longer settlement cycles specified in the Delegated Regulation for minor currencies or in connection with hedging a sale or purchase of securities).
“Commercial Purposes” Exemption
The Delegated Regulation also provides that a physically-settled FX contract which meets all of the following criteria shall not be a MiFID II financial instrument (and accordingly will not be subject to EMIR when MiFID II comes into effect):
- at least one of the parties is an NFC (i.e. not a financial counterparty for EMIR purposes);
- it is entered into to facilitate payment for identifiable goods, services or direct investment; and
- it is not traded on a trading venue.
We will provide further updates on these points when further developments take place.
(1) Directive 2004/39/EC.
(2) Directive 2014/65/EU which comes into force in January 2018.