Response to joint Consultation on draft RTS on risk-mitigation techniques for OTC-derivative contracts not cleared by a CCP
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A potential compromise solution – which would need to be endorsed ex ante by regulators – could be represented by the signing an overarching CSA between groups, where these agree on whether dynamic or static allocation is allowed, by appointing, at Group level, the relevant Legal Entities authorized to deal bilateral OTC derivatives and assign a percentage of the Eur 50 million threshold to each relevant Legal Entity. A renegotiation of an existing overarching/Group-Level CSA would be necessary where any new group entities (appointed by the Group as being allowed for trading) were to be added in the CSA or any change of counterparty status from NFC- to NFC+ should occur.
The definition of “Group” within EMIR (Reg. 648/2012, Art. 2 (16)) includes the case of the Institutional Protection Scheme (IPS, as defined by article 113(7) of Regulation (CRR) 575/2013). While we agree with the inclusion of IPS in the Group’s definition (as EMIR does) when we refer to the clearing exemption (Art. 4(2) EMIR), we believe that an IPS shall not be considered as Group, at least in the case an IPS does not fulfill the conditions of making use of intragroup exemptions, as it occurs in the following specific cases:
a) Exemption from initial margin (article 2 GEN, par. 3);
b) Eligible criteria to avoid wrong-way risk (article 6 LEC, par. 1, point b))
c) Concentration limits for initial and variation margins (article 7 LEC, par. 1, point [a) and] b)).
To that regard, we would like to highlight that, generally, an IPS is made up of several small banks and, at least under the relevant prudential regulation (i.e. CRD IV/CRR package), is not fully treated akin to a consolidated banking group. Therefore, including the IPS in the definition of “Group” for the purposes of the points a) to c) above would bring about unintended consequences since the corresponding requirements will likely impact disproportionately on those small banks which are not integrated in a consolidated banking group.
In addition, the ESAs consultation paper states that (art. 2 GEN, (4)(b)) financial counterparties (FC) and non-financial counterparties (NFC+, as referred to in EMIR, art. 10) may agree not to exchange initial and variation margin for transactions entered into with NFC-. It is important to note that the provision proposed by the ESAs would (1) require changes in the contractual terms under which existing contracts are entered into, which were already updated upon the entry into force of EMIR, and (2) make necessary a re-negotiation of contractual terms with clients to comply with the provision proposed by the ESAS to agree not to exchange IM and VM. This represents one of the aspects of the new framework which would demand significant efforts for the legal and commercial departments, despite that fact that EMIR does not explicitly demands the parties to formally agree in writing not to exchange IM and VM. Indeed, EMIR imposes the exchange of collateral only for FC and NFC+, therefore we deem not appropriate to impose an agreement to avoid exchanging IM and VM for transactions entered into with NFC-.
Further potential issues are highlighted below:
• as it regards the method for IM calculation, the new framework is clearly laid out in a way as to prevent disputes to arise; however, should this occur, regulators should consider to lay out a provision that would allow the parties to a transaction to agree on the identification of one of the counterparties as calculation agent. In this specific case, both parties shall also agree on the identification of a third-party calculation agent which will provide a calculation that will be binding for the parties. The latter solution proposed does represent a way to balance the pervasive powers/rights of the party that would be assigned the role of calculation agent (in the agreement) with the role of a third-party calculation agent, so that this would protect the party that is not being assigned the role of calculation agent.
• The new framework should specify in which way the full disclosure of covered entity should be done to the market; potential solutions should be:
- documenting, during CSA signing, the status of the bilateral counterparties and which one allows IM collection in case entities are fall within the average notional thresholds;
- signing dedicated documentation in which a counterparty certifies its status;
- implementing a single common platform to monitor the status (average notional).
As per Article 1 FP, par. 5, we understand that the new framework does include foreign exchange forwards, swaps and currency swaps. However, we are still convinced that this position should be reconsidered and exclude physically settled FX transactions from the calculation of the average notional of non-centrally cleared OTC derivatives for the purpose of the phase-in period for the application of initial margin (IM). This would preserve consistency with the regulatory framework which excludes such transactions from the scope of the IM exchange requirement. On the same grounds, we believe that the forthcoming RTS should make it explicit that intra-group transactions which have been exempted from the margin requirements are not taken into account for the purpose of the phase-in calculation of the average notional of non-centrally cleared OTC derivatives.
In relation to Art. 1 LEC, ‘Eligibility and treatment of collateral’, we believe that cash assimilated instruments (as defined by article 4(1)(60) of CRR), should be included in point a), par. 1 of Art. 1 LEC provided that the instruments are issued by the collateral taker. Indeed, CRR recognize these instruments as credit risk mitigation instruments and the Delegated Regulation proposed by the ESAs should take this consideration into account in order to keep consistency with the CRR provisions.
Finally, the definition of practical or legal impediment proposed in the consultation paper seems to be too wide and it lays down very strict criteria for entities which are members of the same Institutional Protection Scheme (IPS). We believe the specificities of the IPS should be reflected more appropriately. Many regulatory regimes and all insolvency and resolution regimes, by nature, do contain provisions which can affect the ability of the regulated or insolvent party, or the party under resolution, to effect payments or transfer assets, and, unless such impediment is only deemed to exist upon initiation of such proceedings but not before, it would be impossible for groups and members of the same institutional protection scheme to rely on this exemption.
Question 2. Are there particular aspects, for instance of an operational nature, that are not addressed in an appropriate manner? If yes, please provide the rationale for the concerns and potential solutions.
One of the major issues related to the proposed framework concerns the application of the Eur 50 mln threshold at the level of the consolidated group (to which the threshold is being extended) and is based on all non-centrally cleared derivatives between two consolidated groups, parties to a transaction. More specifically, the issue is related to the potential split of the overall threshold among the different Legal Entities of a group. As initial margins are currently calculated and settled at a local level, the obligation set in the framework would be very demanding to be managed.A potential compromise solution – which would need to be endorsed ex ante by regulators – could be represented by the signing an overarching CSA between groups, where these agree on whether dynamic or static allocation is allowed, by appointing, at Group level, the relevant Legal Entities authorized to deal bilateral OTC derivatives and assign a percentage of the Eur 50 million threshold to each relevant Legal Entity. A renegotiation of an existing overarching/Group-Level CSA would be necessary where any new group entities (appointed by the Group as being allowed for trading) were to be added in the CSA or any change of counterparty status from NFC- to NFC+ should occur.
The definition of “Group” within EMIR (Reg. 648/2012, Art. 2 (16)) includes the case of the Institutional Protection Scheme (IPS, as defined by article 113(7) of Regulation (CRR) 575/2013). While we agree with the inclusion of IPS in the Group’s definition (as EMIR does) when we refer to the clearing exemption (Art. 4(2) EMIR), we believe that an IPS shall not be considered as Group, at least in the case an IPS does not fulfill the conditions of making use of intragroup exemptions, as it occurs in the following specific cases:
a) Exemption from initial margin (article 2 GEN, par. 3);
b) Eligible criteria to avoid wrong-way risk (article 6 LEC, par. 1, point b))
c) Concentration limits for initial and variation margins (article 7 LEC, par. 1, point [a) and] b)).
To that regard, we would like to highlight that, generally, an IPS is made up of several small banks and, at least under the relevant prudential regulation (i.e. CRD IV/CRR package), is not fully treated akin to a consolidated banking group. Therefore, including the IPS in the definition of “Group” for the purposes of the points a) to c) above would bring about unintended consequences since the corresponding requirements will likely impact disproportionately on those small banks which are not integrated in a consolidated banking group.
In addition, the ESAs consultation paper states that (art. 2 GEN, (4)(b)) financial counterparties (FC) and non-financial counterparties (NFC+, as referred to in EMIR, art. 10) may agree not to exchange initial and variation margin for transactions entered into with NFC-. It is important to note that the provision proposed by the ESAs would (1) require changes in the contractual terms under which existing contracts are entered into, which were already updated upon the entry into force of EMIR, and (2) make necessary a re-negotiation of contractual terms with clients to comply with the provision proposed by the ESAS to agree not to exchange IM and VM. This represents one of the aspects of the new framework which would demand significant efforts for the legal and commercial departments, despite that fact that EMIR does not explicitly demands the parties to formally agree in writing not to exchange IM and VM. Indeed, EMIR imposes the exchange of collateral only for FC and NFC+, therefore we deem not appropriate to impose an agreement to avoid exchanging IM and VM for transactions entered into with NFC-.
Further potential issues are highlighted below:
• as it regards the method for IM calculation, the new framework is clearly laid out in a way as to prevent disputes to arise; however, should this occur, regulators should consider to lay out a provision that would allow the parties to a transaction to agree on the identification of one of the counterparties as calculation agent. In this specific case, both parties shall also agree on the identification of a third-party calculation agent which will provide a calculation that will be binding for the parties. The latter solution proposed does represent a way to balance the pervasive powers/rights of the party that would be assigned the role of calculation agent (in the agreement) with the role of a third-party calculation agent, so that this would protect the party that is not being assigned the role of calculation agent.
• The new framework should specify in which way the full disclosure of covered entity should be done to the market; potential solutions should be:
- documenting, during CSA signing, the status of the bilateral counterparties and which one allows IM collection in case entities are fall within the average notional thresholds;
- signing dedicated documentation in which a counterparty certifies its status;
- implementing a single common platform to monitor the status (average notional).
As per Article 1 FP, par. 5, we understand that the new framework does include foreign exchange forwards, swaps and currency swaps. However, we are still convinced that this position should be reconsidered and exclude physically settled FX transactions from the calculation of the average notional of non-centrally cleared OTC derivatives for the purpose of the phase-in period for the application of initial margin (IM). This would preserve consistency with the regulatory framework which excludes such transactions from the scope of the IM exchange requirement. On the same grounds, we believe that the forthcoming RTS should make it explicit that intra-group transactions which have been exempted from the margin requirements are not taken into account for the purpose of the phase-in calculation of the average notional of non-centrally cleared OTC derivatives.
In relation to Art. 1 LEC, ‘Eligibility and treatment of collateral’, we believe that cash assimilated instruments (as defined by article 4(1)(60) of CRR), should be included in point a), par. 1 of Art. 1 LEC provided that the instruments are issued by the collateral taker. Indeed, CRR recognize these instruments as credit risk mitigation instruments and the Delegated Regulation proposed by the ESAs should take this consideration into account in order to keep consistency with the CRR provisions.
Finally, the definition of practical or legal impediment proposed in the consultation paper seems to be too wide and it lays down very strict criteria for entities which are members of the same Institutional Protection Scheme (IPS). We believe the specificities of the IPS should be reflected more appropriately. Many regulatory regimes and all insolvency and resolution regimes, by nature, do contain provisions which can affect the ability of the regulated or insolvent party, or the party under resolution, to effect payments or transfer assets, and, unless such impediment is only deemed to exist upon initiation of such proceedings but not before, it would be impossible for groups and members of the same institutional protection scheme to rely on this exemption.