In general, many small and medium-sized entities are not equipped for the necessary calculations and to actually post IM and VM according to the RTS. New procedures would have to be put in place, and additional expertise would have to be brought into the organisation. Furthermore, many of them will not have sufficient collateral available (either cash or financial instruments).
We believe that the new regulations will result in substantial additional costs for derivatives, both as an effect of the mandatory posting of IM/VM itself, and because of the operational costs. As a consequence parties, in particular a very substantial part of NFC- , will decide not to engage into new OTC derivatives at all.
The requirement for EU entities that are subject to the EMIR margin rules to collect from all non-EU entities (regardless of status or size, even if these are corporates, central banks or sovereigns) VM and IM (if the EU entity and the non-EU entity are above the IM phase-in threshold):
- places EU entities which are active in non-EU jurisdictions at a major competitive disadvantage compared to non-EU entities;
- deprives the non-EU end users of the services provided by EU entities, implying a negative influence on the functioning of the financial markets both within and outside the EU (less supply, less favourable pricing).
We strongly recommend that non-EU entities which would be exempted if they would have been an EU-entity will also be exempted in the RTS. We believe this would not influence the risk of parties in Europe, since the rationale for the exemption is evenly valid for non-EU as for EU entities.
The impact of the RTS on NFC+, and in particular pension funds, might be severe, because many of such parties do not have cash or bonds freely available on their balance sheet for use as collateral. From a banking side we cannot provide details or quantifications, but in general we anticipate that liquid assets eligible for IM and VM will become scarce to a great extent.
Settling initial margin within the same business day is not feasible. This would require a same procedure as with CCPs, where initial margin is pre-funded. This would be very costly for counterparties, and probably impossible operationally. There is a strong need in the market to have the IM settled on T+1 (transaction date plus one business day, according to market practice).
We agree that the requirements set out in the RTS shall only apply to new contracts. Existing contracts are priced under the assumption that no margin is posted. When margining is introduced in existing contracts, their pricing will have to be renegotiated. This would be costly and complex for all parties engaged, and could also have unpredictable effects on markets. We believe that the RTS should provide guidance as to what would qualify as a “new contract” (as used in Recital 18). In our view an amendment of an existing contract should not trigger the creation of a “new contract”, unless the amendment involves either an increase of the notional amount or an extension of the duration.
With each (counter)party in the market having its own margin model, (mandatory) exchanging of models and their parameters and assumptions will be an extremely complex and time consuming exercise. Although we advocate that models already in use remain acceptable, we strongly recommend that a uniform model be used industry-wide and that the EU stimulates associations (e.g. ISDA) to develop such a model on a reasonable term.
Thoroughly back-testing or calibrating a model is time consuming. Therefore, we propose to back-test the model annually, or more frequently if there are indications that the model is not performing as intended.
The definition of “stressed data” is portfolio – and thereby counterparty – dependent. This requirement may make it impossible for counterparties to agree on a calibration period. We propose to calibrate the model on the most recent 8 years.
We appreciate that reliance on ratings by rating agencies is discouraged. However, it is not realistic that banks and other parties develop their own IRB models, apply them to all relevant assets and share all relevant information with counterparties. This would require an army of analysts and lead to higher prices for our counterparties with decreased liquidity if counterparties step out of the market. On longer term counterparties will most likely be necessitated to fall back on external ratings.
We encourage the use of a generic, industry wide model. Regulations/regulators should facilitate such model. Too many models would lead to a very non-transparent market and operational problems. In our opinion it would be good to align the requirements of such a model (e.g. calibration period, recalibration frequency, diversification, and back-test frequency) with the IMM requirements.
We agree that the use of concentration limits is a useful and even necessary element in the management of collateral (IM and VM). At the other hand, we note that the BCBS-IOSCO framework does not include provisions on concentration limits, and that the proposed text differs from the requirements under the CRR. Apart from the latter inconsistency, which is undesirable by itself, the proposed text should be assessed by its effect in practice. When the freedom of counterparties to use and accept less-diversified collateral and to compensate this with broad haircuts is not recognised, many counterparties will be driven away from these markets for the wrong reasons.
Art. 7 LEC specifies concentration limits with regard to the collateral collected from a single individual counterparty. We believe that these provisions can be improved in two directions:
- by imposing comparable limits on a group level: when counterparties belonging to the same group have posted collateral, diversification of the overall-portfolio (on group level) is much more relevant than diversification of the individual collateral portfolios;
- by applying these limits only on amounts exceeding a particular (absolute) limit; relatively small counterparties engaged in relatively small contracts may not even have an investment portfolio allowing diversification as currently specified. Maintaining the proposed wording would lead to unnecessary costly transactions (SFTs) in order to achieve diversification for margining only.
The BCBS-IOSCO framework allows the re-use of IM under conditions; in the proposed SFT Regulation “rehypothecation” is not defined unambiguously; the FSB in its “Policy Framework for Securities Lending and Repos” defines “re-hypothecation” more narrowly as “re-use of client assets”.
There are major arguments to restrict the scope of the “re-use” provisions in the RTS to solely collateral consisting of security interest; transfer of title (of collateral) should not be included in the definition. A transfer of title means that the legal ownership is transferred to the transferee. Imposing an obligation to pre-agree contractually the re-use is in contradiction with the transfer of title principle and in contradiction with the principles of the collateral directive, would be in contradiction with the clearing and margining/collateralisation requirements imposed by EMIR and could lead to substantial legal uncertainty for non-centrally cleared derivatives.
CCPs are allowed to re-use collateral under conditions. Prohibiting re-use in the non-centrally-cleared environment would be an impediment for parties in the chain (forcing them to make money “dead”), and would be incompatible with the conventional approach of the banking industry. We believe it could have a major impact on the economy, if this money could not be re-used.
We recommend that - with the consent of the underlying counterparty - IM can be re-used by the CCP (which is currently allowed), but likewise by the Clearing Members (in case of cleared transactions); main reason is to eliminate a concentration of risk on CCP level and to spread this risk on CM level. In case of non-cleared OTC transactions it should be part of the conditions of a transaction whether the IM can be re-used by the receiving party.