EMIR, or Echternach slow procession
European Market Infrastructure Regulation (better known by its acronym “EMIR”) is the most talked-about of all, especially in the wake of a financial crisis. Hedging foreign exchange (FX), interest rates and commodities is the very basis and essence of the treasurer's job. Risk hedging is the treasurer's DNA. Amending the regulations governing OTC derivatives is certainly a useful way of marking out and securing the markets. However, this must not be to the detriment of companies and the "real economy". Revising EMIR again and again to roll back tried and tested gains and call into question the robustness of a tried and tested system could be highly damaging and counterproductive. Let's look at some of the political ideas that could have a lasting impact on the treasury profession.
Echternach procession ?
Taking three steps forward, only to take two steps back, has never helped anyone move forward. Treasurers and financiers need stability, to know what legislative environment they're operating in. Constant change, however justified, is detrimental to the markets. Uncertainty is never good for market equilibrium. We have seen the extent to which the European Commission, pushed by the European financial watchdog, i.e., ESMA, has tried to propose measures to revise the well-balanced and adjusted EMIR refit. It thought it would leave it to ESLA to review the definition of the concept of hedging, which is a risk. It seems to us that this concept should be perfectly aligned with the definition in IFRS9 (formerly IAS 39), and therefore be largely "principle-based" rather than "rule-based", leaving room for restrained interpretation. It is up to each one of us to demonstrate to the national supervisor that our OTC hedges are indeed allocated to this objective. The principle of the “hedge accounting” exception, if one qualifies for it, should be sufficient to demonstrate the objective pursued. It frequently happens that a company has 100% of its OTC derivative transactions effectively dedicated to hedging. It seems to us, therefore, that there is no point in going back on this definition. Let's be consistent and align our definitions with those of accounting standards.
The second false “good idea" or misconception was to revisit the possibility of exempting inter-company OTC derivative transactions from reporting. Here again, a treasurer hedges the underlying risk of a subsidiary through an internal transaction mirrored on an external transaction with a bank. The intercompany transactions cancel each other out, leaving only the external transaction consolidated. So why on earth report what cancels out? EMIR refit had corrected this nonsense, and now we want to call it into question and take a few steps backwards on the incomprehensible pretext of "greater transparency". The problems of a few energy companies, on products traded on organized markets (and therefore not OTC derivatives) should not impact all industries, and even more so on other products. Regulated products require collateral, and the difficulty of financing this collateral cannot be erased by removing the reporting exemption for inter-company OTC transactions.
Concept of “group”
Moreover, the Commission proposal introduces a change in Article 10(3) by removing the existing reference to the company ‘group’ as regards the OTC derivatives contracts that are considered hedging – and thus do not count towards the calculation of the clearing thresholds. The new wording seems to imply that to meet the ‘hedging exemption’, the underlying business risk would have to be in the same entity carrying out the derivative transaction. With centralized treasury functions this test would hardly ever be met. This is because, with centralized treasury functions, it is the group treasury that enters derivatives transactions with financial markets on behalf of the local business entities that have the underlying business risks. This could de facto lead to the end of all the centralized treasury functions, which are an international best practice well established for all corporates. The rationale behind the article 10.3 change has not been detailed, but the solution is to stay with current EMIR wording. Again, they would alter the essence of treasury function consisting in centralizing operation for efficiency and cost reasons.
Never short of ideas...
But even more worrying are the draft amendments suggesting the removal of the hedging exemption for European non-financial entities (see amendments 305 & 306). European companies are not sitting on piles of cash, and refinancing is becoming a problem as rates rise. Borrowing to put collateral in place to "guarantee" OTC derivative transactions and their "fair value" variations would be complete nonsense. Wouldn't the risk be that European companies would relocate, hedge with counterparties outside the European Union, or even worse, no longer hedge at all? Giving European companies a competitive disadvantage was certainly not the intention of the founding fathers of the union, nor of the current Commission.
No, hedging is not a “nice to have”, but it is a “must have” for EU NFC’s. The “real economy” hopes the current EMIR refit will remain as it is now. Central clearing is not an option for EU NFC’s. If we change the rules, we may kill a market, the hedging and impact corporates. If EU companies are no longer able to manage some risks (i.e., FX, IR, commodities) which are not core business risks, and which their competitors in other parts of the world are still able to manage, that makes EU MNC’s extremely vulnerable in the global economy. Political leaders want to create “EY economic security”, want to grow “EU champions” in strategic sectors, increase competition in Europe. Such a move on EMIR re-refitting would directly impact those ambitions as it would massively put EU MNC’s at a competitive disadvantage. How could we claim to have a vibrant and attractive capital and derivative market if its regulatory regime is pushing its non-financial end users to set up outside of the EU to meet their derivative needs? That is the question we all have in mind, and we expect the EMIR re-refitting will not turn into a sort of Echternach procession.
François Masquelier, CEO of Simply Treasury
Disclaimer: This article was prepared by François Masquelier in his personal capacity. The opinion expressed in this article are the author’s own and do not necessarily reflect the view of the European Association of Corporate Treasurers (i.e., EACT).