To increase transparency in the OTC derivatives markets, the European Market Infrastructure Regulation (“EMIR”) requires certain market participants (the “counterparties”) to centrally clear OTC derivative contracts of specified types (the “clearing obligation”) or to apply risk mitigation techniques set out in Art. 11 of EMIR (the “risk mitigation obligation”). Risk mitigation techniques include, amongst others, portfolio reconciliation, dispute resolution, valuation and margining.
Importantly, the clearing obligation and the risk mitigation obligation extend to OTC derivative contracts where both counterparties are established in one or more countries outside the EU (each, a “third country entity” or “TCE”) and:
- the relevant OTC derivative contract has “a direct, substantial and foreseeable effect“ within the EU; or
- it is “necessary or appropriate” to prevent the evasion of any provisions of EMIR.
The above is commonly referred to as “extraterritoriality” and this note outlines its potential consequences and current market developments.