Joint Committee of ESAs consults on draft RTS on risk mitigation techniques for OTC derivative contracts not cleared by CCP under EMIR
On 14 April 2014, the European Supervisory Authorities (ESAs) issued a consultation on draft RTS on risk-mitigation techniques for OTC-derivative contracts not cleared by a CCP. Specifically, it addresses requirements relating to:
- Counterparties’ risk management procedures
- Methods used to calculate initial and variation margin and operational procedures relating to exchange of margin
- Eligibility and treatment of collateral
- Procedures concerning intragroup derivative contracts
The consultation runs until 14 July 2014.
From a risk management perspective, counterparties to OTCs which are not subject to central clearing must establish robust risk management procedures in order to ensure the timely exchange of collateral. They must also conduct periodic testing of risk management procedures and establish procedures relating to the substitution of collateral.
To seek to prevent the build-up of uncollateralised exposures within the system, the RTS require that counterparties (both financial and non-financial) exchange variation margin on a daily basis. Additionally, and to act as an effective risk mitigant, initial margin requirements must be recalculated at least every 10 days to reflect changes in both the risk positions and market conditions. The RTS recognise that the requirement to exchange collateral for minor valuation movements can lead to an overly onerous collateral exchange obligation. The RTS therefore limit the exchange of collateral to circumstances where significant changes to margin requirements occur. This, together with de minimis thresholds for collateral exchange purposes seeks to limit the operational burden for managing liquidity associated with initial margin requirements.
The RTS are prepared with a view, firstly, to having a broad pool of eligible collateral that also avoids an excessive operational and administrative burden on both supervisors and market participants and, secondly, to ensuring sufficient quality of eligible collateral while also limiting cliff effects. They therefore set out criteria relating to eligibility and requirements for credit assessments and the calculation and application of haircuts. Collateral which is considered suitable must be sufficiently diversified, liquid, not be exposed to excessive credit, market and FX risk and hold their value in a time of financial stress. Furthermore, the value of the collateral should not exhibit a significant positive correlation with the creditworthiness of the counterparty. The ESAs are proposing not to permit re-hypothecation of collateral collected for initial margins.
Intragroup transactions can be exempted from the requirement to exchange collateral if certain risk management requirements are met and there are no “practical or legal impediments on the transferability of own funds and the repayment of liabilities”. In order to ensure consistency of application of this requirement the RTS further clarify which requirements on risk management procedures have to be met, and specify the practical or legal impediments on the transferability of own funds and the repayment of liabilities.
European Commission consults on FX financial instruments
The European Commission, in response to concerns about the adequacy of regulation of FX activity has published a consultation paper to garner views on where the boundary lies between what is, and what is not, an FX financial instrument. Responses to the consultation are due on 9 May 2014.
Specific focus is placed on the definition of a spot FX instrument due to the divergent views of whether or not it is within the scope of MiFID (and therefore, EMIR). For example, the Central Bank is of the view that all FX transactions with settlement beyond the spot date are to be considered forward contracts and therefore within MiFID / EMIR whereas, in the UK, the FCA has indicated that FX contracts are outside of MiFID. The consultation will focus on the length of settlement periods to determine where the cut-off line is between spots and forwards.
ESMA 2014 trade repository supervision work plan
Under EMIR, ESMA is responsible for the direct supervision of the six trade repositories it registered in November 2013. Its trade repository supervision work plan for 2014 details the monitoring and supervisory functions it proposes to carry out. The work plan is indicative of a risk-based approach to supervision. However, it also indicates that ESMA is prepared to use its investigatory powers (such as requests for information, general and on-site investigations) to ensure compliance.
Contributed by Catharine Dwyer
