Question 1

1. What costs will the proposed collateral requirements create for small or medium-sized entities, particular types of counterparties and particular jurisdictions?

As a consequence of the proposed collateral requirements referencing the average amount of outstanding notional (EUR 8 bn being the lowest threshold as of the latest phase-in period), small entities will probably not be touched by IM’s obligation rules, and therefore we would not expect any material costs to impact their activity.

Anyway, concerning medium-sized entities with an average amount of notional above EUR 8 bn, the following costs should be taken into consideration:

• Legal costs to renegotiate existing CSAs or put in place new CSAs covering the changes to existing market practice as outlined in the draft RTS (for example, the gross exchange of IM, margin model references, segregation issues, etc.) Whilst it may be that a Market Protocol would ease the number of renegotiations required for certain industry standard documents, this would still require substantial cost to counterparties in familiarizing themselves with the effect of the amendments and any elections required.
• IT costs related to set up and calculate IM with standardized method; to investigate whether a counterparty is subject to IM rule or not; to store the information in a proper way so as to use it as basis for calculation and to monitor the IM requirements,
• Organizational costs: the costs in setting up strong processes with regard to dispute resolution; setting up new units tasked with the monitoring of the level of re-use and the number of counterparties allowed to enter into re-hypothecation (if any).
• Transaction costs: the costs of exchanging margin.
• Cost of funding in case of posted margins and overall strong processes to ensure an adequate liquidity framework to perform margining payments.
• Costs of liquidity management particularly due to gross posting and IM segregation (with limited possibility to re-use the IM so need to access the market to gather liquidity).

Depending on whether the entity subject to the proposed requirements chooses to pay/receive IM only on new transactions or to submit the whole portfolio, different costs are expected to arise: in the first case they will arise from the segregation of affected transactions and the greater complexity in the calculation; while in the case where the whole portfolio is affected, the concerned entity can have netting mitigation effect within asset classes and will likely have a greater impact in terms of expected IM to pay depending on the overall position with that particular counterparty.

2. Is it possible to quantify these costs?

It is quite hard to quantify all the mentioned costs: it depends on lots of variables and managerial decisions, related for instance to insourcing or outsourcing management, size of the entity and the liquidity of the underlying market.

3. How could the costs be reduced without compromising the objective of sound risk management and keeping the proposal aligned with international standards?

In UniCredit’s opinion, the segregation of the entire IM received is quite a tough request. Re-hyphotecation should be permitted. In order for the proposal to be aligned with international standards, UniCredit suggests to focus on a strict monitoring of the re-use into the entity’s liquidity framework.

Costs can also be reduced by the application of higher thresholds and the risks associated with this could be lowered by increasing the margining frequency (e.g. 5 business days).

In addition, UniCredit is of the opinion that a regulatory proposal where the internal standardized model is defined in detail would contribute to limit costs. In fact, in case the internal standardized model is not a priori well defined by the regulator and too many degrees of freedom are left to the bank, each bank would develop its own standardized model. If this is a case, a bank’s own model risks to diverge from another banks’ model. And divergent models could lead to costly disputes.
Question 2

1. 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.

The major issue related to the new regulation is the application of the threshold of EUR 50 mln at the level of the consolidated group based on all non-centrally cleared derivatives between the two consolidated groups. This gives rise to operational issues in respect of how to split the overall threshold among different legal entities within the group and how this should be drafted in the CSA itself due to the fact that IM is calculated and settled at local level. As a result, this requirement would operationally be very difficult to manage.

Other potential issues are highlighted below:

- The chosen method for IM calculation: in case counterparties apply different IM calculation models, potential disputes can arise. To provide a remedy, regulators may consider the obligation to have counterparties agreeing on the appointment of one IM calculation agent (for instance, if a counterparty is subject to internal model methods (“IMM“) for IM calculation, the other counterparty can also benefit" from this calculation if there is one appointed "calculation agent").
That means that the calculation agent is responsible for all covered entities of the counterparty group in the event that it acts as the main entity with whom the counterparty does business.
- The use of IMM could in itself lead to issues in case the “calculation agent” counterparty has the need to recalibrate models or change methodologies: in fact, a recalibration or change of a model by a bank could be perceived as a unilateral change under a bilateral agreement which could be challenged by the other counterparty. A bank’s ability to upgrade / change models could be therefore negatively impacted. A possible solution could be that IMM counterparty has to give full disclosure of the change but no agreement by the other counterparty needs to be requested.
- Issues can also be highlighted within different legal entities of the same group: the calculation model can be different at legal entity level in order to avoid huge investments for the relatively smaller legal entity of a Group subject to the new Regulation or a "calculation agent" within the Group can be appointed.
- A possibility for a covered entity to decide upon a model per asset class (either standardized or internal model) coupled with the proposal in the underlying RTS draft, “If an internal model ceases to comply with regulatory requirements internal processes shall be flexible enough to allow for changing from an internal to a standardized model” increases complexity. Besides the required processes to be established internally, there is a need for strong alignment with the counterparty. Both internal and external processes are resource-intensive and increase the risk of having disputes.
- As the definition of MTA is applied to the sum of IM and VM, this introduces more complexity at an operational level. This is due to the fact that IM has to be compared at a group level for calculating thresholds, but the net amount of IM and VM has to be taken into account at the legal entity level for purposes of the MTA application. This complexity can lead to disputes. Considering the different meaning of single MTA components we recommend to have different MTA for IM and for VM respectively.
- The regulation should also specify in which way the status of the covered entity should be publicly disclosed to the market and how the average notional thresholds can be monitored.
- Collection of IM and VM should be subject to the standard settlement cycle; it cannot be daily if e.g. securities settle at T+2.
- Segregation of IM and delivery of collateral in case of default has to take into account internal processes of third party custodians; therefore “immediate” delivery of collateral should be revised by the regulator.
- There will be additional impacts on internal processes, mainly on concentration limits monitoring and application of IRB on the rating side: we would also expect that more disputes need to be managed."
Question 3

1. Does the proposal adequately address the risks and concerns of counterparties to derivatives in cover pools or should the requirements be further tightened?

UniCredit considers that the proposal adequately addresses the risk for Covered Pool OTC derivatives in respect of hedging IR or CCY risk.

However, it would be desirable to reach a deeper harmonization across existing regulations within the European Union. This is especially with regard to minimum requirements in terms of over-collateralisation requested, even if, for example, in Italy, Rating Agencies tend to apply large haircuts to bonds that are part of a covered pool. We think that existing covered bonds rules are sufficient to grant an adequate degree of protection to the counterparty of the hedging derivative transaction without applying the IM initiative (e.g. protection against counterparty downgrade clause, termination events clause, etc ).

2. Are the requirements, such as the use of CRR instead of a UCITS definition of covered bonds, necessary ones to address the risks adequately?

UniCredit agrees with the proposed requirements. With particular reference to the use of CRR instead of the UCITS definition of covered bonds, we point out that article 129 of the CRR provides specific rules for banks’ exposures in the form of covered bonds whereas the UCITS V (art. 52.4) only contains a definition (to which the CRR itself refers) for setting up investment limits of UCITS.

In this respect, we also highlight that the relevant Italian regulatory framework, (Law no. 130/1999 as amended) identifies new eligible asset classes for covered pools. UniCredit thereby support an enlargement of the CRR definition so as to incentivize covered bond issuances without increasing risk.

3. Is the market-based solution as outlined in the cost-benefit analysis section, e.g. where a third party would post the collateral on behalf of the covered bond issuer/cover pool, an adequate and feasible alternative for covered bonds which do not meet the conditions mentioned in the proposed technical standards?

In Italy, we do not consider it necessary for a third party to post the collateral on behalf of the covered bond issuer/cover pool due to the fact that all the mentioned conditions are fulfilled by the dedicated Covered Bonds regulations for issuance.
The intervention of a third party would be expensive as well as very complex to manage.
Question 4

1. 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?

The adoption of counterparty IRB models may likely lead parties to have IRB models which differ significantly from each other, especially when influenced by their own local regulatory frameworks/requirements. Hence disputes may arise due to these many differing models. In saying that, UniCredit recognises that the IRB rating models are subject to supervisory assessment for approval and the regulatory authorisation requires comprehensive information to be provided and the transparency and reliability principles to be satisfied. This may ensure appropriate transparency and demonstrate adequate understanding to supervisory authorities while also ensuring access to disclosure and reliability.
Question 5

1. How would the introduction of concentration limits impact the management of collateral (please provide if possible quantitative information)?

The introduction of concentration limits could have the following impacts:
• More costs: IT costs for pre-booking check; post-booking monitoring; establishing a new monitoring unit; establishing new processes within the bank; documentation (such as CSA) renegotiation, etc.
• Should limits be exceeded, a negotiation for collateral substitution has to be performed.

2. Are there arguments for exempting specific securities from concentration limits and how could negative effects be mitigated?

Concentration limits can be modeled to naturally exempt the strongest issuances in terms of rating classes, concentration of issuance, collateral types and counterparty types. Rather than being a real exemption, a huge percentage in the composition analysis assigned to AA issuers can of course avoid breaches in these kind of issuances, reduce risks and facilitate the use of best currencies and issuances as collateral.

In UniCredit’s view, these new technical standards are trying to reduce the risk of difficulty to liquidate positions if they are too large. Nonetheless, these risks are largely mitigated if securities can be refinanced with central banks. Accordingly, an exemption can be considered for securities rated min AA- to recognise suitable credit worthiness and for those classified as high liquidity L1, potentially associated to an absolute notional cap (i.e holdings of any single “exempt” issuer provided by a counterparty cannot be higher than EUR 500 mln – 1 bln).

3. What are the pros and cons of exempting securities issued by the governments or central banks of the same jurisdiction?

Pros would be the high liquidity of the securities received which would therefore be easily sellable in case of counterparty’s default, eligibility to central banks, lower haircut applied and the lower cost of monitoring if the bank accepts this kind of collateral only.

Cons would be the high correlation between the counterparty and the issuer in case of country default so a sort of generic wrong way risk (gWWR) can be detected.

Nevertheless, this kind of correlation is inevitable as counterparties tend to be natural holders of their sovereign paper. As long as ratings of the sovereign are maintained at high levels, acceptance of this kind of correlation risk should be allowed. It should also be noted that sovereigns tend to slide to default rather than jump to default. This allows for management of positions and replacement of collateral if minimum rating language is included in the documentation.

4. Should proportionality requirements be introduced, if yes, how should these be calibrated to prevent liquidation issues under stressed market conditions?

Proportionality requirements should definitely be incorporated to avoid an extreme diversification and fragmentation of the exchanges for very small collateral positions and a continuous collateral substitution request that can trigger more costs and cannot be performed in case of stressed market conditions.

To prevent liquidity issues under stressed market conditions, proportionality requirements should be introduced per collateral type and rating class setting maximum holding amounts above which the concentration limits start (i.e margin in AA EU Gov no concentration if < EUR 500 mln, etc).
Question 6

1. How will market participants be able to ensure the fulfillment of all the conditions for the reuse of initial margins as required in the BCBS-IOSCO framework?

It may be difficult to fulfill all the requirements.

In particular, major difficulties are related to: high costs of registering the collateral received as “reused”, the identification of counterparties permitted or not to re-use collateral, the difficulty in finding a “buy-side” counterparty with average notional above EUR 8 bln threshold. We in fact expects that the majority of counterparties subject to the regulation would be on the buy side as well on the sell side of a transaction, hence the possibility to re-use the initial margin would not apply.

If a Regulator wants to limit the re-use of IM received, it could allow a percentage of the received collateral to be reused in bilateral transactions, CCP postings or at least allow the re-use to Central Banks in order to permit banks to gather liquidity in case of need.

2. 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?

For cash collateral, every company would want to re-use it – if only to pay credit interest on collateral to the counterpart. Smaller dealers/banks that don’t trade OTC derivatives actively but do offer risk management solutions to their clients would also need to re-use collateral, especially to hedge their exposure to larger dealers.