What obligations will small non-financial companies (NFC-) domiciled in Switzerland face under the new laws regulating OTC derivatives? What do the new laws have in common with EMIR - and what are the main differences? What issues do German parent companies need to be aware of with regard to their Swiss subsidiaries?
The Financial Market Infrastructure Act [FinfraG in German, FMIA in English] and the Financial Market Infrastructure Regulation [FinfraV in German, FMIR in English] took effect on 1 January 2016. While FMIA contains the basic rules and regulations governing OTC derivatives in Switzerland, rather like EMIR does in the EU, FMIR fleshes out the legal provisions in greater detail as a "level II" text.
What transactions fall under the scope of FMIA and how is the clearing obligation identified?
To identify relevant transactions, all fully consolidated group companies worldwide must be screened for transactions that are classed as derivatives in accordance with FMIA. Derivatives are defined as financial contracts whose value depends on one or more underlying assets and which do not constitute cash transactions. As under EMIR, contracts recognised in the accounts as derivatives - such as conventional foreign exchange or interest rate derivatives - thus usually require no further investigation of whether or not they genuinely constitute derivatives.
Properly classifying contracts for the physical delivery of goods is more difficult, however. Under FMIA, any such contract which can be exchange-traded, traded via an organised on-the-floor (OTF) trading platform or - at the discretion of one of the contractual parties - settled in cash (i.e. where non-contingent cash settlement is possible) must be classified as a derivative. Only if none of these conditions apply is a transaction not governed by the new law.
As with EMIR, companies must therefore check all contracts throughout the consolidated group in light of these criteria. In this regard, the Swiss legislator has, on the one hand, made its law less complex than EMIR by waiving the need for complex screening for what are referred to as "other derivative financial instruments". On the other hand, the inclusion of OTF trading adds a criterion which, until further notice, will lead to legal uncertainty among Swiss companies. Why? Because neither Switzerland nor the EU's ESMA authority has yet produced a list of what trading platforms are classified as OTF.
FMIA's provisions governing the calculation of clearing thresholds closely follow those of EMIR. A floating average of nominal volumes must be calculated for all open OTC derivatives that are not part of a hedging relationship. This must be done for a period of 30 days for the various asset classes. A hedging relationship exists if the derivatives were concluded to reduce business or liquidity risks. Alongside hedge accounting in accordance with IFRS, it is also permissible to use portfolio, proxy or macro-hedging in accordance with international standards such as US GAAP and Swiss GAAP FER.
Intra-group transactions for which no hedging relationship can be proven must also be factored into the calculation, as must voluntarily cleared derivatives. The high clearing threshold per asset class is similar to that of EMIR. A threshold of CHF 1.1 billion is defined for credit and equity derivatives, and a threshold of CHF 3.3 billion for interest rate, foreign exchange, commodity and other derivatives.
Unlike under EMIR, opposing positions with an identical underlying instrument, currency and maturity can be netted even if they have different counterparties. Moreover, forward exchange transactions and currency swaps do not have to be factored into the calculation if they are settled on a delivery versus payment basis. OTC derivatives from financial counterparties which are fully consolidated in the group (e.g. group banks or pension funds) must also be included to determine the relevant thresholds.
What reporting duties must NFC- fulfil?
Essentially, all counterparties must fulfil reporting requirements, irrespective of their status. The same goes for OTC-traded and exchange-traded external and intra-group derivatives (EFDs). New derivatives and amendments to existing derivatives must be reported on the following working day. As with the Dodd-Frank Act (DFA), however, the reporting requirement is unilateral only. In addition, derivatives concluded between NFC- are excluded from reporting requirements. As a result, inter-group derivatives do not normally have to be reported. Nor is there any back-loading requirement for derivatives accumulated before reporting became compulsory. Where derivatives are concluded with companies of a higher status (e.g. banks), it is always the counterparty (i.e. the bank) which must submit the report.
NFC- could be required to submit reports if, for example, they conclude derivatives with banks other than Swiss banks, and if these banks submit reports neither under FMIA nor under any legal ruling recognized as equivalent to FMIA. The regulator has yet to make decisions on formal equivalence. For reporting purposes, however, the current interpretation is that equivalence is given where the content of reports agrees on certain material points. Accordingly, EMIR reports from banks domiciled in the EU would satisfy FMIA reporting requirements.
What risk mitigation methods must NFC- comply with?
Compliance with the risk mitigation methods anchored in FMIA - contractual confirmation, portfolio alignment, dispute settlement and portfolio compression - must be given for external and uncleared intra-group OTC derivatives. Other aspects in which FMIA and EMIR are in agreement include confirmation deadlines, the need for a bilateral agreement with the counterparty on compliance with risk mitigation methods before a derivative is concluded, and the need to document - at least twice a year - whether portfolio compression has been necessary. As under EMIR, the obligation to mark outstanding OTC contracts to market every day and the obligation to trade over a platform do not apply for NFC-.
On the other hand, it is not necessary to synchronize derivative portfolios for which another NFC- is the counterparty. Forward exchange contracts and currency swaps are exempted from risk mitigation methods.
When are the rulings compulsory for NFC-?
While the reporting obligation for NFC- and their open OTC derivatives must be met at the latest twelve months after initial approval or recognition of a transaction register by FINMA, the obligation to report exchange-traded derivatives (ETDs) takes effect only after 18 months. Since no transaction register is yet officially recognized in Switzerland, the reporting obligation will not apply to NFC- until mid-February 2017 at the earliest.
The implementation of risk mitigation methods is compulsory for NFC- as of 1 July 2017, i.e. 18 months after FMIR took effect. As with EMIR, central clearing only concerns large non-financial counterparties (NFC+) and large financial counterparties (FC+). As of 2017, audits in relation to FMIA will be compulsory for NFCs.
Source: KPMG Corporate Treasury News, Edition 52, February 2016
Author: Christian Debus, Partner, CDebus@kpmg.com
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