Response to joint Consultation on draft RTS on risk-mitigation techniques for OTC-derivative contracts not cleared by a CCP
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The explanatory notes suggest that the exemptions were introduced to ease the operational burden and insure proportionate implementation of margining requirements. We welcome and agree with such considerations. However, the requirement of a positive election agreement (whether in writing or other equivalent electronic means) in order to benefit from exemptions seems in contradiction with such objective. Indeed, it will create administrative burden even for exempted counterparties, products, implementation phases. The benefit of phasing-in would be watered down as long as it does not reduce the documentation burden. The exemptions should therefore be structured a direct exemptions not requiring an opt-out (positive election). If contractual agreements are deemed to be necessary, this could be achieved by an obligation on all counterparties which are or become subject to the margin requirements to put in place the appropriate documentation (that is as of the time they become subject thereto).
It is not clear whether formal documentation is required where the transactions were entered into with exempted entities under Article 2 GEN 4 (b) and (c) i.e. NFC- of article 10 EMIR and sovereigns/supranational entities of Article 1 (4)/(5) EMIR. Indeed, the introductory section refers to writing or equivalent means only with respect to FC and NFC+, while such agreement is stated to be made with respect to “following” including (b) and (c). If so, the entities intended to be exempted would still be affected through the corresponding documentation requirement in order to benefit from the exemption.
It is not clear whether a written form is also required to be repeated each time the parties do not reach the phase-in thresholds in Article 1 FP (3) (i.e. are not subject to IM). Re-documenting all derivatives relationships with all (including exempted) counterparties seems disproportionate to the goal of fostering financial stability. In other words, we believe that where an exemption is available for practical exchange of collateral, it shall be consistently available for documentary requirements.
It is not clear what constitutes “other equivalent permanent electronic means” as alternative to writing and how this can ease the operational burden. As already mentioned above, the relevant agreements would involve negotiations and thus do not lend themselves to electronic standards (not a binary decision). In addition a significant portion of the affected counterparties will not have access to such electronic means and protocol system such as the one established for ISDA master agreements (see response to Question 1 on the limits of the use of protocol systems).
The operation burden of collateral substitution due to concentration limits of collateral must be addressed more appropriately. This requirement will result in increased settlement risks and new functionality requirements in Collateral Management systems.
The haircut on collateral for FX mismatch will result in more collateral movements and operational risks. They way exposure is calculated in CM systems will also be affected with requirements on developments as a result.
It would be helpful, if the definition of “currency mismatch” (on page 50 in the Consultation Paper) were clarified. We do not understand what is meant by settlement currency. It could, for example, mean the currency in which non-collateral payments are made in respect of a transaction, but this would not be meaningful for cross currency swaps or other transactions with payments in multiple currencies. Alternatively, it could mean any currency in which settlements may be made for the transaction, but this would then include the collateral payments themselves. Or it could have other meanings, including the base currency, but this may seldom be used for payments except for termination determinations. The haircut of 8% ought to be lower for currency pairs with low volatility, e.g. when one currency is pegged to another.
The RTS should make it clear that:
1. Netting across asset classes for the purposes of calculating VM is permitted. Article 1 GEN (3)(b) refers to collection of VM on a net basis, but this is not carried through to Article 1 VM.
2. Uncleared OTC derivatives between members of the same group should not be included in the calculation of the IM phase-in threshold. This is consistent with the application of the EUR50m IM threshold between consolidated groups. If not, there is a double-counting effect for back-to-back transactions to transfer market risk to the group member who holds the market making book and/or who contracts with external parties. This may cause a group to exceed an IM phase-in threshold when such back-to-back trading does not really represent incremental systemic risk.
The EBF considers that the setting up of the following two registers would facilitate the application of the margin rules by EU entities:
1. A public register of NFC+s. As each non-financial counterparty who exceeds the clearing threshold is required to notify ESMA and its competent authority under article 10(1) of EMIR, ESMA is in a position to maintain and publish a public register of each EU entity that is an NFC+.
2. A public register of EU FCs and NFC+s who are a member of a group whose aggregate month-end average notional amount of uncleared OTC derivatives exceeds the prevailing IM phase-in threshold. This could be combined with a requirement for such EU FCs and NFC+s to notify ESMA and their competent authorities by the 30 September following the applicable calculation period if their group exceeds or has ceased to exceed the applicable IM threshold for the next following annual period. This is consistent with paragraph 8.10 of the BCBS-IOSCO framework document.
This would help market participants to accurately apply the IM and VM requirements and reduce the reliance on representations from its counterparty to establish if and to what extent it must apply the margin rules to new transactions with that counterparty.
As far as collection of margins is concerned, the RTS foresee that this is done within one business day following the transaction date. However, standard settlement regimes applicable to securities are generally between 1 and 3 days. Hence, counterparties posting securities as collateral could be in breach of the RTS if collection of collateral is not consistent with securities settlement delays. Next to that, we would like to know to what point in time on the term “collection” itself refers to: it is not clear if this is the point of calculation, claiming or actually receiving collateral.
The EBF supports the introduction of more clarity around the definition of Minimum Transfer Amount (MTA). The MTA should be defined as per the current market practise as the minimum (threshold) amount that has to be settled between counterparties on any business day. By referring to collateral amount" it is not clear whether the definition refers to the cumulative full value or the collateral amount to be exchanged on that day.
The provision on the MTA in Article 2 GEN (4) (a) and (6) demands that the amount is calculated as the total amount of all initial margins and variation margins to be posted, that is without differentiating between variation and initial margin. The function and understanding of this MTA differs significantly from current practice. The operational introduction of this new MTA concept will be extremely challenging since it would require the implementation of new and very complex allocation and monitoring systems. In addition, the proposed new MTA concept could defeat the purpose of the MTA: Once the total amount is breached, even very minor differences (which occur regularly) would trigger margin calls needing to be processed (effective zero threshold), resulting in unnecessary and, considering the very limited risks involved, unreasonable additional operational burdens. Electronic processing can reduce these effects only to a limited extent and, is in any event, not an option in relation to those counterparties, which have no access to such electronic processing (in particular smaller and medium sized counterparties). In this context it should be taken into account that the risk exposure of credit institutions would, in any way, be addressed by existing the capital requirements under the CRR.
The described negative effects could be minimised by introducing two separate total MTAs, on for variation margins and another for initial margins, and an additional operative de-minimis threshold for any margin call (e.g. to the amount of 50,000 €).
We further propose to delete the last half sentence of Chapter 1, Article 2 GEN, paragraph 3 (p.23 of the draft RTS) which sets out the requirement to “hold capital” where no initial margin is to be exchanged (“and that they will hold capital against their exposure to their counterparties”. Such a requirement to hold capital requirements is unnecessary and may cause misunderstandings: FCs are, of course, already subject to (regulatory) capital requirements under the CRR. These, however, do not and are not intended to apply to NFC. Such requirements can also not be imposed by contractual agreement, not least because it would be impossible to determine whether the other counterparty complies with such an obligation.
We would welcome a clarification that no threshold other than Minimum Transfer Amount with respect to Variation Margin is authorised. Indeed, the second paragraph on the page 8 referring to a “minimum exchange threshold” of EUR 500,000 may lead to confusion and be interpreted as another threshold on the top of the Minimum Transfer Amount (where “margin requirement exceeds EUR 500,000”). Regardless, it is industry’s view is that the MTA should be applicable to IM and VM independently. By making it applicable to the consolidated figure of IM and VM, it would not only be operationally complex and intensive but inconsistent with current market practice."
The counterparty providing the model will of course need to provide appropriate information on the model to the counterparties to be confident in accessing sufficient information.
Ultimately, we believe that the best approach will be the application of a unified margin model as this will greatly reduce the complexities and operational problems since all counterparties relying on this unified model will have a common understanding of the information required for this model and the manner in which it is to be implemented. We support the use of internal models for determining collateral haircuts. However, these haircut estimates should not be run separately from the IM model themselves. To not take into account any correlations between the unsecured exposure, collateral or exchange rates, is likely to lead to more disputes than if they were otherwise taken into account.
Also, we believe that the standard schedule proposed would be overly penal in a number of cases, e.g. Danish Flex bonds are given a minimum 12% haircut for >5y issues, which could be harmful to the both issuers of and investors in these bonds.
The requirements set out in BCBS-IOSCO are well suited to ensure high level protection of the original collateral. Some requirements for rehypothecation of collateral are also provided for in other European regulations.
We suggest that cash may be reinvested (instead of not re-used at all) in a very restricted range of products, which would be in line with the approach retained in the ESMA guidelines for UCITS.
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.
A need for a vast number of various agreements, for the purpose of not exchanging initial and variation margin, is required (positive election requirement). This will pose a significant operational burden, in particular with respect to the relationship to small and medium sized entities (see also response to Question 1 on the effects of this positive election requirement on small and medium sized companies).The explanatory notes suggest that the exemptions were introduced to ease the operational burden and insure proportionate implementation of margining requirements. We welcome and agree with such considerations. However, the requirement of a positive election agreement (whether in writing or other equivalent electronic means) in order to benefit from exemptions seems in contradiction with such objective. Indeed, it will create administrative burden even for exempted counterparties, products, implementation phases. The benefit of phasing-in would be watered down as long as it does not reduce the documentation burden. The exemptions should therefore be structured a direct exemptions not requiring an opt-out (positive election). If contractual agreements are deemed to be necessary, this could be achieved by an obligation on all counterparties which are or become subject to the margin requirements to put in place the appropriate documentation (that is as of the time they become subject thereto).
It is not clear whether formal documentation is required where the transactions were entered into with exempted entities under Article 2 GEN 4 (b) and (c) i.e. NFC- of article 10 EMIR and sovereigns/supranational entities of Article 1 (4)/(5) EMIR. Indeed, the introductory section refers to writing or equivalent means only with respect to FC and NFC+, while such agreement is stated to be made with respect to “following” including (b) and (c). If so, the entities intended to be exempted would still be affected through the corresponding documentation requirement in order to benefit from the exemption.
It is not clear whether a written form is also required to be repeated each time the parties do not reach the phase-in thresholds in Article 1 FP (3) (i.e. are not subject to IM). Re-documenting all derivatives relationships with all (including exempted) counterparties seems disproportionate to the goal of fostering financial stability. In other words, we believe that where an exemption is available for practical exchange of collateral, it shall be consistently available for documentary requirements.
It is not clear what constitutes “other equivalent permanent electronic means” as alternative to writing and how this can ease the operational burden. As already mentioned above, the relevant agreements would involve negotiations and thus do not lend themselves to electronic standards (not a binary decision). In addition a significant portion of the affected counterparties will not have access to such electronic means and protocol system such as the one established for ISDA master agreements (see response to Question 1 on the limits of the use of protocol systems).
The operation burden of collateral substitution due to concentration limits of collateral must be addressed more appropriately. This requirement will result in increased settlement risks and new functionality requirements in Collateral Management systems.
The haircut on collateral for FX mismatch will result in more collateral movements and operational risks. They way exposure is calculated in CM systems will also be affected with requirements on developments as a result.
It would be helpful, if the definition of “currency mismatch” (on page 50 in the Consultation Paper) were clarified. We do not understand what is meant by settlement currency. It could, for example, mean the currency in which non-collateral payments are made in respect of a transaction, but this would not be meaningful for cross currency swaps or other transactions with payments in multiple currencies. Alternatively, it could mean any currency in which settlements may be made for the transaction, but this would then include the collateral payments themselves. Or it could have other meanings, including the base currency, but this may seldom be used for payments except for termination determinations. The haircut of 8% ought to be lower for currency pairs with low volatility, e.g. when one currency is pegged to another.
The RTS should make it clear that:
1. Netting across asset classes for the purposes of calculating VM is permitted. Article 1 GEN (3)(b) refers to collection of VM on a net basis, but this is not carried through to Article 1 VM.
2. Uncleared OTC derivatives between members of the same group should not be included in the calculation of the IM phase-in threshold. This is consistent with the application of the EUR50m IM threshold between consolidated groups. If not, there is a double-counting effect for back-to-back transactions to transfer market risk to the group member who holds the market making book and/or who contracts with external parties. This may cause a group to exceed an IM phase-in threshold when such back-to-back trading does not really represent incremental systemic risk.
The EBF considers that the setting up of the following two registers would facilitate the application of the margin rules by EU entities:
1. A public register of NFC+s. As each non-financial counterparty who exceeds the clearing threshold is required to notify ESMA and its competent authority under article 10(1) of EMIR, ESMA is in a position to maintain and publish a public register of each EU entity that is an NFC+.
2. A public register of EU FCs and NFC+s who are a member of a group whose aggregate month-end average notional amount of uncleared OTC derivatives exceeds the prevailing IM phase-in threshold. This could be combined with a requirement for such EU FCs and NFC+s to notify ESMA and their competent authorities by the 30 September following the applicable calculation period if their group exceeds or has ceased to exceed the applicable IM threshold for the next following annual period. This is consistent with paragraph 8.10 of the BCBS-IOSCO framework document.
This would help market participants to accurately apply the IM and VM requirements and reduce the reliance on representations from its counterparty to establish if and to what extent it must apply the margin rules to new transactions with that counterparty.
As far as collection of margins is concerned, the RTS foresee that this is done within one business day following the transaction date. However, standard settlement regimes applicable to securities are generally between 1 and 3 days. Hence, counterparties posting securities as collateral could be in breach of the RTS if collection of collateral is not consistent with securities settlement delays. Next to that, we would like to know to what point in time on the term “collection” itself refers to: it is not clear if this is the point of calculation, claiming or actually receiving collateral.
The EBF supports the introduction of more clarity around the definition of Minimum Transfer Amount (MTA). The MTA should be defined as per the current market practise as the minimum (threshold) amount that has to be settled between counterparties on any business day. By referring to collateral amount" it is not clear whether the definition refers to the cumulative full value or the collateral amount to be exchanged on that day.
The provision on the MTA in Article 2 GEN (4) (a) and (6) demands that the amount is calculated as the total amount of all initial margins and variation margins to be posted, that is without differentiating between variation and initial margin. The function and understanding of this MTA differs significantly from current practice. The operational introduction of this new MTA concept will be extremely challenging since it would require the implementation of new and very complex allocation and monitoring systems. In addition, the proposed new MTA concept could defeat the purpose of the MTA: Once the total amount is breached, even very minor differences (which occur regularly) would trigger margin calls needing to be processed (effective zero threshold), resulting in unnecessary and, considering the very limited risks involved, unreasonable additional operational burdens. Electronic processing can reduce these effects only to a limited extent and, is in any event, not an option in relation to those counterparties, which have no access to such electronic processing (in particular smaller and medium sized counterparties). In this context it should be taken into account that the risk exposure of credit institutions would, in any way, be addressed by existing the capital requirements under the CRR.
The described negative effects could be minimised by introducing two separate total MTAs, on for variation margins and another for initial margins, and an additional operative de-minimis threshold for any margin call (e.g. to the amount of 50,000 €).
We further propose to delete the last half sentence of Chapter 1, Article 2 GEN, paragraph 3 (p.23 of the draft RTS) which sets out the requirement to “hold capital” where no initial margin is to be exchanged (“and that they will hold capital against their exposure to their counterparties”. Such a requirement to hold capital requirements is unnecessary and may cause misunderstandings: FCs are, of course, already subject to (regulatory) capital requirements under the CRR. These, however, do not and are not intended to apply to NFC. Such requirements can also not be imposed by contractual agreement, not least because it would be impossible to determine whether the other counterparty complies with such an obligation.
We would welcome a clarification that no threshold other than Minimum Transfer Amount with respect to Variation Margin is authorised. Indeed, the second paragraph on the page 8 referring to a “minimum exchange threshold” of EUR 500,000 may lead to confusion and be interpreted as another threshold on the top of the Minimum Transfer Amount (where “margin requirement exceeds EUR 500,000”). Regardless, it is industry’s view is that the MTA should be applicable to IM and VM independently. By making it applicable to the consolidated figure of IM and VM, it would not only be operationally complex and intensive but inconsistent with current market practice."
Question 4. In respect of the use of a counterparty IRB model, are the counterparties confident that they will be able to access sufficient information to ensure appropriate transparency and to allow them to demonstrate an adequate understanding to their supervisory authority?
At this stage it is not clear whether the proposed rules on the use of IRB models are suitable for practical purposes, in particular if it realistic for the parties to share sufficient information about the IRB model to be used.The counterparty providing the model will of course need to provide appropriate information on the model to the counterparties to be confident in accessing sufficient information.
Ultimately, we believe that the best approach will be the application of a unified margin model as this will greatly reduce the complexities and operational problems since all counterparties relying on this unified model will have a common understanding of the information required for this model and the manner in which it is to be implemented. We support the use of internal models for determining collateral haircuts. However, these haircut estimates should not be run separately from the IM model themselves. To not take into account any correlations between the unsecured exposure, collateral or exchange rates, is likely to lead to more disputes than if they were otherwise taken into account.
Also, we believe that the standard schedule proposed would be overly penal in a number of cases, e.g. Danish Flex bonds are given a minimum 12% haircut for >5y issues, which could be harmful to the both issuers of and investors in these bonds.
Question 6. How will market participants be able to ensure the fulfilment of all the conditions for the reuse of initial margins as required in the BCBS-IOSCO framework? Can the respondents identify which companies in the EU would require reuse or re-hypothecation of collateral as an essential component of their business models?
In European law-making, one should always ensure that the capability of European companies to create growth is not harmed with more stringent requirements. A level playing field between different markets is crucial especially in derivatives markets which are global in nature. Therefore we urge ESAs to follow the flexibility provided in global rules and ensure a level playing field for European companies. In that respect, we would like to point out that the scope of instruments covered under EMIR is wider than under the Dodd-Frank Act. Financial instruments such as equity options or derivatives on equity indices are neither considered “swaps” nor “security based swaps” in the US and consequently are not subject to margin requirements, contrary to the rules in Europe. This creates a major competitive disadvantage for European banks.The requirements set out in BCBS-IOSCO are well suited to ensure high level protection of the original collateral. Some requirements for rehypothecation of collateral are also provided for in other European regulations.
We suggest that cash may be reinvested (instead of not re-used at all) in a very restricted range of products, which would be in line with the approach retained in the ESMA guidelines for UCITS.