- Alternative processes to post collateral (Recital 8)

Recital 8 of the draft RTS addresses the issue that the legal enforceability of the collateral segregation arrangements may not be sufficiently certain under the legal framework of a certain jurisdiction. According to this recital, the addressees of the obligations would be obligated to identify alternative processes to post collateral under these circumstances. The recital itself mentions the possibility to rely on third parties situated in another “safe” jurisdiction. In the public hearing, the possibility to elect the application of the laws of another jurisdictions was mentioned as a further example. In addition, it was further explained that more specific provisions had not been included intentionally in order to give the market participants some flexibility to implement alternative processes. We of course welcome this approach and indeed believe that market participants will need some discretion in order to address any unforeseeable legal challenges which they may face when trying to implement collateralisation arrangements in various jurisdictions, in particular third country jurisdictions.

However, this necessary room for discretion is currently only addressed in the form of a recital and is not reflected in any way in the regulatory provisions as such. To ensure that the market participants indeed retain some flexibility in devising alternative approaches, it would be helpful if the possibility were also addressed in the provisions themselves. This should include, but not be limited to, the possibility to deviate to some extent from the reciprocal (two-sided) nature of the obligation by only collecting or posting collateral unilaterally.

Such further discretion to deviate from reciprocal collateralisation and segregation will specifically be required in relation to transactions with counterparties based in jurisdictions where effective segregation of collateral cannot be ascertained and netting agreements are not (or not sufficiently) legally protected or recognised under applicable insolvency law. Here, the involvement of third party custodians situated in a netting and segregation supporting jurisdiction and/or the election of the laws and courts of such jurisdiction lone may not sufficiently safeguard the effectiveness of netting and segregation agreements in the case of an insolvency and an exchange of collateral may actually increase the risk exposure of the posting party rather than reducing it.

In such circumstances, alternative approaches will need to be permissible which go beyond the involvement of third parties and election of the laws and courts of supportive jurisdictions. Such further alternative approaches should include (without intending to limit the choice of other, effective alternatives)

• Reliance on third party guarantees securing the obligations of the relevant counterparty
• The introduction of a threshold amount for uncollateralised transactions for specific circumstances/jurisdictions/markets.

When it comes to posting margin to counterparties in non-netting jurisdictions (whether third countries or EU, as the case may be), it may not be feasible to find satisfactory alternative arrangements (other than through the gross based capital charges). Since the requirement to post margin could increase the systemic risk in the transactions with counterparties located in jurisdictions where the close-out netting is not enforceable, EBF would recommend to remove the obligation to post collateral in the context of transactions entered into with counterparties domiciled in jurisdictions in which the close-out netting would not be enforceable upon insolvency of a local party or where it is not possible to guarantee the effectiveness of the segregation agreements.

- Treatment of non-EU non-financial counterparties (Art. 2 GEN):

The EBF welcomes the equality of treatment to ensure level playing fields internationally, and in particular the ESAs proposal to exclude from the EMIR margin rules non-EU entities that if based in the EU would be non-financial counterparties.
The EBF would also seek clarifications about the exact treatment of non-EU sovereigns and specifically whether they will benefit from the same exemptions than the ones for EU sovereigns. We note that the proposed Article 3 GEN seems to be flexible enough to consider this issue however we would appreciate if the ESAs could expressly indicate what the applicable regime in such a case is.

- Exchange of margins with third country entities (Art. 3 GEN):

The draft RTS requires posting margins to the third country counterparties, whether the third country is willing or able to receive the collateral assets in a way compliant with the EU regulations. As a result, when trading with EU counterparties, third country entities would not only face a higher transaction cost which is already created by the obligation to post margin to the EU based counterparty, they would furthermore face an infrastructure cost associated with the collection of margin in a way that fully complies with the EU regulations. Such third country entities may not be willing to engage heavy resources to comply with the regulation which is not imposed by their home regulator. As a result, they may stop trading with the EU counterparties, therefore third country entities should not be obliged to collect margin from their EU counterparties.

- Definitions (Art. 2 GEN)

Art. 2 GEN uses the term “non-financial entity” in this context (distinguishing between third country-counterparties which are “financial entities” or “non-financial entities” equivalent to NFC+ on the one hand and “non-financial entities” which are not equivalent to NFC+). The term “financial entity” presumably is intended to capture entities which are equivalent to FCs as defined under EMIR. However, term is currently undefined, which may lead to uncertainties. It could therefore be considered to incorporate a definition of “financial entity” or even third country financial entity as well as non-financial entity.

Although this follows from the context and the underlying objectives of EMIR it could also be considered in this connection to include a clarification to the effect that the obligations also need not be applied in relation to counterparties which do not even qualify as NFC (such as non-undertakings or counterparties falling within the scope of Art. 1 (4) and (5) EMIR or equivalent thereto).

- Procedural character of the obligations (no formal opt-out agreements) – Art. 1 GEN and Art. 2 to 4 GEN

We further welcome the fact that the revised draft RTS now underline the procedural character of the obligations, and, as one consequence thereof, no longer require the entering into formal agreements with each counterparty, even those not qualifying as FC or NFC+ (and equivalent third country counterparties), in order to be able to rely on existing exemptions from collecting and exchanging variation and initial margin. This approach to describe the obligations primarily as procedural without detailed formal requirements ensures that it will not be necessary to approach every single market participant with the sole purpose of formally agreeing on an opt-out from collateralisation (and the connected contractual documentation). This significantly reduces the burden for the addressees of the obligations as well of the numerous market participants which are not intended to be captured by the margin requirements.

- European counterparties have the obligation to assess the legal enforceability of the netting and segregation agreements

We understand the need for legally effective and enforceable netting and segregation arrangements. We welcome that the original requirement for the legal opinion on effectiveness of the IM segregation has been replaced by a less cumbersome requirement of an internal legal review.

Indeed, EBF considers that the requirement to post margin could increase the systemic risk in the transactions with counterparties located in jurisdictions where the close-out netting is not enforceable and would recommend to remove the obligation to post collateral in the context of transactions entered into with counterparties domiciled in jurisdictions in which the close-out netting would not be enforceable upon insolvency of a local party or where it is not possible to guarantee the effectiveness of the segregation agreements.

- Foreign Exchange Contracts (Art. 5 GEN)

Art. 5 (c) GEN including recital 17 demanding that cross-currency swaps is split up and only the FX forward is part of the exemption seems unpractical because currency swaps is registered as one transaction.

- Threshold based on initial margin amount (Art. 6 GEN)

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 EUR 50m 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 EUR 50m threshold set out is to be calculated between counterparties at a group level. We suggest introducing a possibility to exclude some group entities, which are financial counterparties, e.g. life insurance companies, pension funds or asset managers, which would make the calculation of the threshold less complicated.

The margin requirements should not apply to legacy uncleared OTC derivatives that are transferred to an EU entity where such transfer is to comply with systems similar to the one proposed under the EU Bank Structural Reform regulation. This would increase the burden on EU entities subject to EU Bank Structural Reform regulations to fund margin collateral as a consequence of such entities complying with EU member state requirements, when such arrangements could necessarily be viewed as reducing incremental systemic risk (as opposed to increasing it). This may also cause a group to exceed any IM phase-in threshold when that group is merely complying with its wider EU obligations.

The derivatives cleared on voluntary basis i.e. in absence of mandate, should not be counted toward the IM phase-in threshold. This could be clarified for the avoidance of doubt.

- Treatment of derivatives associated to covered bonds swaps for hedging purposes (Art. 8 GEN)

We suggest removing the requirement for covered bond issuers/cover pools to collect VM (and for counterparties of the third-country covered bond issuers to post VM). In many jurisdictions, covered bonds issuers are not currently collecting VM in practice, although in theory the collateral arrangements are in place and can be triggered upon occurrence of certain events. The current approved standard for covered bonds linked collateral agreements provides for high thresholds and downgrading triggers which in some cases give rise to the transfers of collateral. A new structure which would require collecting VM without thresholds may have a negative effect on the covered bond activity in general. Covered bonds issuers would have to build an infrastructure to allow collecting and maintaining the variation margin in a way compliant with the regulations, including the eligibility criteria monitoring etc. The cost of hedging the covered bonds would significantly increase, as the hedging counterparties are not currently posting collateral in vast majority of cases. The requirement for the hedging counterparties to post VM to their covered bond counterparties without application of the industry standard thresholds and rating triggers would have a major effect on pricing and thus a negative knock on effect on the covered bond issues in general. In line with the objectives of the EMIR regulation, the margining rules should address the systemic risks in the flow OTC derivatives market where a regulatory framework have not already provided for satisfactory safety net from the risk management perspective. In parallel, the new requirements should preserve the existing well-functioning structures with clear benefit for the financial markets and the economy as a whole. The covered bond framework is a regulated one and already subject to thorough scrutiny of the rating agencies. Therefore, it does not seem to be a natural focus of this margining regulation.

- Provisions concerning the covered bonds (pages 30 and 31)

EBF welcomes the ESAs’ proposed treatment of derivatives associated to covered bonds for hedging purposes. Indeed, the proposed wording of Article 8 GEN (2) (b) ensures the exemption from margin requirements (i) where the counterparty to the OTC derivative contract ranks at least pari-passu with the covered bond holders and also (ii) where such counterparty does not rank pari-passu with said covered bond holders because it is either the “defaulting” party or the “affected” party.

This EBF’s request was linked to the “flip clause”, applicable for both SFH and SCF covered bonds programs. Our purpose was to mirror the clause included in the covered bonds documentation and which refers to the cases where the derivatives counterparty is the “defaulting” or the “affected party”. This clause triggers the loss of the senior rank of the derivatives counterparty in the payment priority order of the privileged creditors.

However, not all covered bond programs have flip clauses and it is not a requirement in all covered bond legislations to have such. It is therefore essential that Article 8 GEN (2) (b) is not constructed so as to require flip clauses (it shall only provide for that possibility). In our view the proposed wording of Article 8 GEN (2) (b) is not clear in this respect and we therefore propose that it is formulated as follows:

“[…] (b) The counterparty to the OTC derivative contract ranks at least pari passu with the covered bond holders, except that a more junior ranking is permitted where the counterparty to the OTC derivative concluded with covered bond issuers or with cover pools for covered bonds is the defaulting or the affected party”.

The clearing and other risk management procedures in EMIR and in the EU delegated legislation issued under EMIR (such as the draft RTS) only applies to derivative transactions which involve two or more counterparties. Hence, the rules do not apply with respect to derivatives transactions entered into within the same legal entity (see EMSA’s response to TR Question 14 in the EMIR Q&A). If , in accordance with national legislation and upon prior approval by its competent authority, a bank issues covered bond issues, all such hedging arrangements are made within the same legal entity. It would be both desirable and advantageous to clarify that the RTS does not apply to such internal hedging transactions.

- Scope

It is crucial to avoid any major disruption of competition for banks subject to EMIR and for their clients and to ensure a level playing field between all markets participants involved in the global OTC derivative market. Any material divergence between the European framework and other regimes will increase market fragmentation, reduce market depth and liquidity and increase the price dispersions. In this context, the EBF considers that harmonisation is still needed, notably in the scope of financial instruments. Indeed, the scope of instruments covered by EMIR is wider than in the US where neither variation margin nor initial margin is required for physically-settled FX forwards and swaps in US and where instruments such as equity options and derivatives on equity indices are neither considered as “swaps” nor as “security based swaps” under the ‘Dodd-Frank Act’ and hence are not subject to the margin requirements set out by BCBS-IOSCO. Consequently, EU firms may be rejected from third country markets if they have to collect initial margins on these instruments while other banks do not.