The general framework will deliver the EBA’s remit under CRR2 Article 403. However, the overall consequence of CRR2 Article 403 when applied to tri-party repo is that it will reduce the pool of collateral and liquidity in the market, as mentioned in our general comments. This is because institutions (collateral receivers) will need to set and instruct conservative large exposure rules in order for institutions to comply with their regulatory obligations.
Please see our letter (uploaded with the electronic consultation form) for our general observations, including the impact on the provision of collateral in the market (ie, a reduction of the pool of collateral and liquidity).
The list of safeguards in section 4.2.2 is generally OK (subject to our comments below and in Q4).
However, this list does not need to be replicated in the contract with the tri-party agent. Rather, there should be a general contractual obligation to ensure compliance with the limits and/or a regulatory obligation imposed on the tri-party agent to ensure it has appropriate safeguards / controls in place to enable the institution’s compliance with the limits instructed by the institution. Whether any of the specific safeguards should be listed in the contract should be a matter left for negotiation between the tri-party agent and its client.
It is worth noting that the safeguarding of collateral held in custody is already a heavily regulated service under MiFID2.
The proposed requirement in paragraph 12(g) for the right of the institution or a legitimate third party (inter alia the statutory auditor, the competent authority or third parties appointed by them) to verify the tri-party agent’s compliance with the safeguards, is generally OK, but must be subject to appropriate advance notification and confidentiality obligations, as one would expect in any contractual provision dealing with audit rights.
The proposed requirement in paragraph 14 to obtain a written declaration of assurance is an unnecessary layer. The contractual undertaking and a prompt notification obligation in the agreement would ensure perpetual on-going compliance with the limits at all times and prompt notification if they are breached. The written declaration gives an institution no additional level of comfort over and above the independent internal and external audits that will be conducted on the process under existing regulatory requirements.
In regard to the notification requirement, we recommend that this is a prompt notification requirement rather than an immediate notification requirement, as it is not realistic to expect notification to occur in real time. In addition, we would recommend a clarification to ensure that notification can occur electronically and through existing online systems.
BNY Mellon as tri-party agent can generate intra-day reports at certain intervals, but it is not practicable to require the generation and distribution of real-time nor near-time reports, due to the dynamic nature of collateral allocation. Our online system is available to clients whereby the client’s graphical user interface (GUI) enables the client to identify concentration limit breaches based on the instructed limits, in addition to the system notifications we would issue.
This is a matter for institutions – as a tri-party agent, we do not have a specific view on this question.
The meaning of the words “margin of conservatism” are sufficiently clear to us as a tri-party agent, but ultimately how to apply a “margin of conservatism” is a question for each institution to determine, and institutions may have a different risk appetite in this regard.
Given that institutions need to take into account various factors under paragraph 18, we think that in practice, the institution would need to instruct the tri-party agent with a limit based on an absolute amount rather than the percentage value of a specific type of security in the portfolio.
We do not have a view on this question.
Whilst the general approach seems reasonable, it should be noted that a tri-party agent cannot grant a client a unilateral right to set a concentration limit (as part of the contract between the client and triparty collateral agent), as this would violate the agent’s neutral role.
BNY Mellon as tri-party agent can enable clients to agree with each other that one or both parties can unilaterally set concentration limits in respect of the other – but contractually this is an agreement between the clients, and it has a commercial impact that will be priced into the relevant trades.
We would also note that the setting of concentration limits does not occur in a commercial vacuum. The concentration limits that may be set in regard to a particular trade can impact the price of the trade - therefore the concentration limit cannot typically be changed unilaterally by one party during the lifecycle of the trade as it would have an impact on how it had been priced. Generally both parties to the trade would need to agree to the change. Taking this into account, it may require institutions to apply that “margin of conservatism” for limit setting, when negotiating the original trade.
We also note the following as current market practice: where a large exposure limit is breached (which will be identified by the clients themselves through their own systems that monitor all types of large exposures, not just tri-party exposures), clients would typically rather prefer to amend the concentration limits for single bilateral trades, rather than instructing changes of concentration limits to tri-party agents. This is more practical to clients, as they would isolate the market impact / liquidity impact to a single trade, rather than risking a spill-over effect to an entire portfolio of trades.
Therefore, we would advise against imposing any requirement to force unilateral rights to change concentration limits into all tri-party repo trades. The provision of client access to the online platforms of tri-party agents that facilitate the change of collateral schedules in a prompt manner – even where the counterparty needs to agree to these – is a reasonable and sufficient approach.
Please see our response to Question 8.
Paragraphs 25-27 would in practice impose an unnecessary level of audit and due diligence upon tri-party agents. Adequate assurance can be provided through the imposition of regulatory obligations on tri-party agents, national competent authority supervision and the requirement for internal / external audit of the systems.
Yes, tri-party agents have in place such controls that would facilitate the management of the instructed limits – noting that the effect of CRR2 Article 403 and implementation of instructed limits, and the possibility of revisions to limits, will reduce the pool of collateral and liquidity in the market.
There is no need for control mechanisms to be more precise or prescriptive.
In regard to material concerns regarding service agreements referred to in paragraph 35(e)(ii), the proposed requirement in paragraph 12(g) for the right of the institution or a legitimate third party to verify compliance with the safeguards, is generally OK, but must be subject to appropriate advance notification and confidentiality obligations, as one would expect in any contractual provision dealing with audit rights.