GLOBAL - The notion of "contracts linked to commercial activities/treasury financing" within the European Market Infrastructure Regulation (EMIR) could lead non-financial entities such as pension funds to engage in "dangerous behaviour", the International Swaps and Derivatives Association (ISDA) has warned.

Responding to the European Securities and Markets Authority (ESMA) on the draft technical standards for the implementation of EMIR, the ISDA said it was concerned about the interpretation of references to contracts that were linked to their commercial activities or treasury financing activities.

According to the association, the interpretation made could be "overly narrow" and impact non-financial entities using derivatives for "genuine" hedging strategies.

"An example of such overly narrow construction is the proposed exclusion of equity hedging of stock option plans," it said.

"It is important to recognise that this type of hedging is entered into primarily for the purpose of covering a genuine economic risk and is not speculative in nature, and, therefore, it would be inappropriate for it to be counted towards the clearing threshold."

In its response, the ISDA went on to say that the same logic applied to equity options used for the repurchase of a company's own shares as mandated by the general assembly of shareholders.

The association called on ESMA to state precisely in the EMIR text that the risks, which are linked to commercial activities or treasury financing activities, can include any "genuine hedging of operations", including operating expenses linked to pension and employee plans.

Failing to do so could otherwise push non-financial entities to review their hedging strategies due to the central clearing requirements, taking therefore more risk, according to the ISDA.

"Excluding equity hedging from the carve out may encourage NFCs [non-financial companies] to engage in dangerous behaviour and avoid hedging genuine economic exposures in an effort not to exceed clearing thresholds," it added.

ESMA published its consultation paper on technical standards for OTC derivatives trades under the EMIR regulation at the end of June, reiterating its aim to reduce risks via the use of central clearing and risk mitigation techniques.

The consultation process, which closed on 5 August, addressed draft Regulatory Technical Standards (RTS) and draft Implementing Technical Standards (ITS).

Both RTS and ITS aim to set out the specific details of how Brussels is to implement EMIR's requirements.