Fairmat, the pricing solution to meet EMIR 648/2012 risk mitigation quantitative requirements

Fairmat, the pricing solution to meet EMIR 648/2012 risk mitigation quantitative requirements

The UE legal framework

Starting from 11 August 2014, financial counterparties (1) and non financial counterparties which breach the threshold (so called NFC+) "that enter into an OTC derivative contract not cleared by a CCP, shall ensure, exercising due diligence, that appropriate procedures and arrangements are in place to measure, monitor and mitigate operational risk and counterparty credit risk, including at least:

(...) formalised processes which are robust, resilient and auditable in order to reconcile portfolios, to manage the associated risk and to identify disputes between parties early and resolve them, and to monitor the value of outstanding contracts.

These entities that enter into an OTC derivative contract shall mark-to-market on a daily basis the value of outstanding contracts. Where market conditions prevent marking-to-market, reliable and prudent marking - to - model shall be used.

These legal requirements relative to the EU Regulation 648/2012 (EMIR), in force since 15 March 2013, were later revised in a technical report published by ESMA on 27 September 2012. Article 15 of this technical report clarifies the market conditions that prevent marking-to-market valuation for an OTC derivative contract:

  • the market is inactive;
  • the range of reasonable fair values estimates is significant and the probabilities of the various estimates cannot reasonably be assessed.

It is reasonable that to verify that the range of fair values is significant, making a mark to model for all positions is a real need for the entire portfolio of OTC derivative contracts.

ESMA requirements for  when marking-to-model, financial and non-financial counterparties shall have a model that:

  • incorporates all factors that counterparties would consider in setting a price, including using as much as possible marking-to-market information;
  • is consistent with accepted economic methodologies for pricing financial instruments;
  • is calibrated and tested for validity using prices from any observable current market transactions in the same financial instrument or based on any available observable market data;
  • is validated and monitored independently, by another division than the division taking the risk;
  • is duly documented and approved by the board of directors as frequently as is necessary, following any material change and at least annually. This approval may be delegated to a committee.

On Art.12 of  UE 648/2012 "EMIR" guideline is indicated that each Member States shall lay down the rules on penalties applicable to infringements of the rules under this Title and shall take all measures necessary to ensure that they are implemented. Those penalties shall include at least administrative fines. The penalties provided for shall be effective, proportionate and dissuasive.

Given this law framework, Fairmat offers both an independent valuation service and a software solution compliant with ESMA requirements.

Independent Valuation Service

By the mean of its parent Consulting Company, IFA Consulting, Fairmat solutions were used to valuate and analyse thousands of financial contracts since 2002.

IFA Consulting, a 18 ter TUF (Italian Consolidated Law on Financial Intermediation) and MiFid Compliant Company, became the Italian market leader in financial litigation support, advising the most relevant case in the domestic market like Parmalat, City of Milan, Region of Apulia (see in detail our companies curriculum).

With a consolidated team of quantitative analysts, PhD and physics and by leveraging on Fairmat Technology, our Companies are at your disposal to perform independent valuations of your portfolios.  

Contact us to get more informations about our independent valuation services.

Fairmat Software Solution

With our software solution any quantitative analyst can easily define any OTC derivatives contract (even those with complex structure and payoffs) for all asset classes. You can also:

  • use the contributed theoretical models or analyses or even add your legacy model or analyses and integrate it seamlessy. An indispensable feature for marking - to - model purposes.
  • integrate your market data provider or input your custom market data. 
  • have properly documented theoretical model and analyses that can also be examined directly with the typical modes of the open source world (no black box). This feature makes Fairmat useful for identifying disputes between parties and suitable for audit needs.

Once you have designed an OTC derivatives contract,  functional analysts can even more easily enter similar contracts and then perform valuations or analyses, monitor and track the value and other metrics of outstanding portfolio.

For further informations, contact us here.

References

Regulation (EU) n. 648/2012 EMIR

ESMA Final Technical Standard Report under the Regulation (EU) n.648/2012

What does EMIR mean for Non financial Counterparties