EMIR

EMIR is the European Market Infrastructure Regulation, which regulates over-the-counter (OTC) derivatives in the European Union. Implemented in 2012 and updated in 2019, EMIR requires that most standardized derivatives be cleared through central counterparties, reported to trade repositories, and subject to risk-management requirements. EMIR is the European equivalent of Title VII of the Dodd-Frank Act, which regulates swaps in the US. Together with MiFID II, EMIR forms the backbone of EU financial regulation.

Central clearing and counterparty risk

Before EMIR, most OTC derivatives were traded directly between two counterparties (dealer-to-client) without a central counterparty. If one counterparty failed, the other faced credit risk — the counterparty might not pay.

The 2008 financial crisis exposed this risk. When Lehman Brothers failed, institutions holding Lehman swaps suffered huge losses. The solution was central clearing: derivatives would be novated (exchanged) through a central counterparty, which guarantees every trade.

EMIR requires that standardized OTC derivatives (particularly interest-rate swaps and credit-default swaps) be cleared through a registered clearinghouse. A clearinghouse stands in the middle — it is the buyer to every seller and the seller to every buyer. If one side defaults, the clearinghouse absorbs the loss (until then covered by margin posted by participants).

Trade reporting and transparency

EMIR requires reporting of derivative trades to trade repositories (databases of derivative transactions). This provides regulators with visibility into the derivatives market. Before EMIR, the size and nature of the OTC derivatives market were largely opaque.

Trade data is now available to regulators and, in some cases, to the public. This has improved understanding of systemic risk and enabled enforcement of market abuse rules.

Risk management: initial and variation margin

EMIR imposes risk-management requirements. Counterparties to OTC derivatives (either cleared or non-cleared) must exchange initial margin (collateral posted upfront) and variation margin (daily settlements based on price changes). These margins are meant to protect each party against default by the other.

The margin requirements have been gradually tightened — starting with large dealers, now extending to non-financial corporates with large derivatives portfolios.

Non-cleared derivatives and the hedge exemption

Not all derivatives must be cleared. Custom, non-standardized derivatives can remain in the bilateral OTC market. However, EMIR imposes margin requirements on non-cleared derivatives to mimic the risk reduction from clearing.

There is also a hedge exemption: companies using derivatives to hedge operational risks (like a manufacturer hedging currency exposure) may be exempt from some clearing or margin requirements.

Cross-border implications and extra-territoriality

EMIR applies to EU firms and, to some extent, to non-EU firms dealing with EU counterparties. This has created tension with the US, which has its own derivatives regulation (the Dodd-Frank Act). EU and US regulators have tried to coordinate — accepting each other’s rules as equivalent in some cases — but some duplicative compliance is unavoidable.

A global derivatives dealer must comply with EMIR for EU trades and Dodd-Frank for US trades, and the rules differ (which clearinghouses qualify, margin calculation methods, etc.).

ESMA oversight

EMIR is administered by national regulators and coordinated by ESMA. ESMA has regulatory powers over clearinghouses (registering them, imposing margin limits) and can issue guidelines binding on national regulators.

See also