Synthetic derivatives are financial contracts designed to replicate the economic exposure of a traditional asset or derivative, without directly owning the underlying instrument. They are often created by combining two or more standard financial instruments, such as options, forwards or swaps, to replicate a desired position synthetically. These instruments are commonly used in structured finance when direct access to a market is limited or more tailored exposure is needed. For example, a firm may use a combination of options and swaps to create a synthetic equity or credit position.
Are Synthetic Derivatives Reportable Under EMIR?
Synthetic derivatives are subject to reporting requirements under the European Market Infrastructure Regulation (EMIR) when they are traded OTC and meet the definition of a derivative under the Markets in Financial Instruments Directive II (MiFID II). Although the term “synthetic derivative” is not explicitly used in the EMIR Refit guidelines, the regulation applies broadly to all OTC derivatives, including bespoke and complex contracts that replicate traditional market exposures. According to the European Securities and Markets Authority (ESMA), the structure or complexity of a contract does not affect whether it is reportable. If a synthetic contract functions like a derivative and is traded OTC, then it falls within the scope of EMIR. That means it must be reported to an authorised trade repository (TR) by the close of the following working day (T+1).
EMIR Reporting Obligations for Synthetic Derivatives
Synthetic derivatives are distinctive as they are often built from multiple underlying components. From a regulatory perspective, the structure is less important than the function of the derivative for regulatory reporting. If the combined structure is classified as a derivative and is executed OTC, then the entire synthetic position must be captured in EMIR transaction reports. Despite the complexity of the underlying structure, the reporting format for synthetic derivatives remains standardised and includes:
- Legal Entity Identifiers (LEIs) for both counterparties
- Notional value and underlying currency
- Time and date of trade
- Contract maturity and settlement details
- Valuation and collateral (where applicable)
Reporting Challenges for Firms
Firms face two main challenges when reporting synthetic derivatives, which must be understood to ensure accurate reporting. The EMIR Refit mandates the use of Unique Product Identifiers (UPIs) for the classification of all derivatives. As synthetic derivatives are often unique and complex arrangements, they are not typically assignable to a standard UPI. Firms should analyse the synthetic contract and select the most appropriate UPI based on which traditional derivative it most closely represents. Another key challenge for firms is whether to report synthetic derivatives as a single transaction or separately as each individual leg. If the component parts are executed as separate, legally binding agreements then it is usually recommended to report each leg separately. However, if they are structured within a single, legally binding contract that creates a unified exposure, then it is reasonable to report them as one transaction. Synthetic derivatives can be complex and bespoke, but their EMIR reporting obligations remain standardised when traded OTC. Firms must ensure that they understand when a synthetic contract qualifies as a derivative and adhere to their reporting obligations to maintain transparency and compliance in EU markets. Unsure how EMIR applies to your synthetic derivatives?
Contact Novatus Global today for expert guidance on navigating reporting requirements and managing complex structures with confidence.
