FINANCIAL INSTITUTIONS
ENERGY
INFRASTRUCTURE, MINING AND COMMODITIES
TRANSPORT
TECHNOLOGY AND INNOVATION
PHARMACEUTICALS AND LIFE SCIENCES
40 Minute Briefing
European and domestic reform: The day
after tomorrow – EMIR, CASS & MiFID
Hannah Meakin, Partner
Norton Rose LLP
5 December 2012
Introduction and timing
Introduction
• Timing
• The latest on client clearing
• Proposed changes to CASS
• Impact on trading structures
Timeline: EMIR, MiFID and CASS
August
2012: EMIR
enters into
force
EMIR
MiFID
20 June
2012:
Council of
the EU
begins
publishing
compromise
proposals
Late Q1
2013: Most
RTS
expected
to enter
into force
European
Parliament
considers legislative
proposals in plenary
and refers them to
ECON for
reconsideration 2526 October 2012
Q4 2013: First
clearing
obligations
expected to
apply
2013
December
2012:
Final rules
on Part I
CP12/22
expected
1 January 2013:
Handbook rules in
PS12/20 will come into
effect
From 1 January
2014 at the
earliest:
Reporting
obligations for
credit and IRS
apply
1 July 2015:
Trades start
to be
reported to
ESMA where
there is no
trade
repository
Implementation
of MiFiD II
legislative
proposals (at
the earliest)
4
December
2012:
ECOFIN
meeting
2012
CASS
First half
2013: ESMA
expected to
consult on
collaterisation
From 1 July
2013 at the
earliest:
Reporting
obligations
for credit and
IRS apply
First half 2013:
FSA feedback on
Parts II and III
CP12/22 expected
2014
2015
The latest on client clearing
A quick reminder of the obligations in EMIR
Clearing
• OTC derivatives entered into or novated that are listed on ESMA
register must be cleared through a CCP
• Applies to transactions between:
– Two financial counterparties
– A financial counterparty and an in-scope non-financial counterparty
– Two in-scope non-financial counterparties
– A financial counterparty or an in-scope non-financial counterparty and a
third country entity that would be subject to clearing if established in EU
– Two third country entities that would be subject to clearing obligation if
established in EU provided (a) contract has direct, substantial and
foreseeable effect in EU or (b) if necessary and appropriate to prevent
evasion of EMIR
• Very few exemptions
• Kicks in on date obligation takes effect but some contracts existing at
that date will need to be front loaded
• All OTC derivatives that are not CCP cleared
Risk management
• Timely, electronic confirmations, portfolio reconciliation, portfolio
compression and dispute resolution
• Daily marking to market or marking to model
• Timely and appropriate exchange of collateral, segregated where
possible
• Hold capital to manage risk not covered by exchange of collateral
Reporting
• All derivatives concluded and any modification or termination must be
reported to a trade repository
• No later than the following working day
• Can delegate but must avoid duplication
• Backloading provisions
A typical clearing structure
B
Central
Counterparty
S
B
S
Clearing
Member
(principal)
Clearing
Member
(principal)
Back-off contract
Back-off contract
Clearing Agreement
B
S
Asset Manager (agent)
S
Fund
(principal)
B
Clearing Agreement
S
B
Counterparty(
principal)
Client clearing: Segregation and porting

In order to comply with clearing obligation, a counterparty must:
– Become a Clearing Member of a CCP or a Client of a Clearing Member
– Establish indirect clearing arrangements with a Clearing Member

CCPs and Clearing Members must offer both:
– Omnibus client segregation
– Individual client segregation






Requirement to distinguish involves recording in separate accounts and not netting across
accounts, not exposing assets in one to losses in another
CCPs must allow Clearing Members to open further accounts for their Clients
CCPs and Clearing Members must disclose levels of protection and costs - must be
reasonable commercial terms
CCPs must commit to trigger procedure for porting - if Clearing Member becomes insolvent
and Client so requests, transfer Client positions and assets to another agreed Clearing
Member
CCPs can actively manage their risks by liquidating positions and assets if this cannot be
done within a pre-defined timeframe
Client collateral can only be used to cover positions held for relevant Client account and
any surplus on a Clearing Member default should be returned to Client or, if not possible, to
Clearing Member for relevant Client account
Omnibus segregation: Books and records
Clearing Member books
and records
Client 1
CCP books and
records
Client 1
Clients 1, 2 + 3
Client 2
Client 2
Client 3
Client 3
Clearing
Member
Clearing
Member
Individual segregation: Books and records
Clearing Member books
and records
CCP books and
records
Client 1
Client 1
Client 1
Client 2
Client 2
Client 2
Client 3
Client 3
Client 3
Clearing
Member
Clearing
Member
Client clearing: Porting
CCP
Cleared Contract,
Rules, provision of
collateral
Clearing Member
Back-up Clearing
Member
Back off contracts,
Clearing Agreement,
CCP mandated
documentation,
provision of collateral
Client
OTC Counterparty
OTC derivative trade
Porting of positions
and assets takes
place on Clearing
Member default
Omnibus and individual segregation compared
Omnibus
Individual
Assets and positions
recorded in separate
accounts
Distinguish positions and assets of Clients
from those of Clearing Member
Distinguish positions and assets of one
Client from those of any other Client and
from Clearing Member
No netting of positions
recorded on different
accounts
Means positions of one Client in an
account can be netted with positions of
other Clients in same account
Positions of Client in that account can be
netted
Assets covering
positions in one
account are not
exposed to losses
related to positions in
another account
Means assets of one Client in an account
can cover positions connected to losses on
positions of other Clients in same account
so fellow Client risk exists
Assets of Client can only be used to cover
that Client’s positions in that account so no
fellow Client risk
Excess collateral
Margin in excess of Client’s requirement
can be held at Clearing Member level
Margin in excess of Client’s requirement
must be ported to CCP and not held by
Clearing Member
Porting
Likely to be more difficult
Should be more likely
Detailed risks depend on exact set-up and operation of accounts
Choice of accounts: Questions


Omnibus or individual account at CCP
level?

Client money protection or not at Clearing
Member level





Title transfer or security interest



Possible choice of sub-pool if omnibus
client account with client money protection


Clearing Member must offer both
May offer variations – e.g. if omnibus, may
be choice of net or gross margining
Client money currently incompatible with
porting but will change
N/A if Clearing Member is a bank
N/A if margin if provided for on title transfer
(and not retail)
Cash or securities?
Clearing Member may need to transfer to
CCP so will need right of use if security
interest
Sub-pools are subject of FSA Consultation
Objective is to facilitate porting in net
margined omnibus accounts
Indirect Client clearing

Client to honour obligations of Indirect Client to Clearing
Member – contract between three parties

CCP will, on Clearing Member’s request, maintain
separate records and accounts to enable Client to
distinguish its positions and assets from those of Indirect
Client

If Clearing Member wants to offer indirect clearing:
CCP
Clearing Member
Client
–
Implement individual and omnibus type accounts in its books and
records
–
Establish procedures to manage a Client default including:
–

Indirect Client

–
Mechanism for porting positions and assets to an alternative Client or the
Clearing Member
–
Allowing for prompt liquidation of positions and assets and return of balance
to Indirect Client
Publish terms and manage risks of arrangement
If Client wants to provide indirect clearing:
–
It must be an authorised credit institution or investment firm or
equivalent third country entity
–
Offer Indirect Clients choice of individual and omnibus type
accounts and inform Indirect Clients of risks including details of
porting arrangements
If Client defaults, information about Indirect Client is given
to Clearing Member
Proposed changes to CASS
Changes to CASS required by EMIR

Existing client money regime undermines porting



FSA has consulted on amendments to CASS (CP12/22)




–
–

Final text expected in December 2012
Clearing Member must notify CCP but need not obtain trust
acknowledgements
Clarifies that a firm can hold excess client money in a client
transaction account if required to do so by law
On Clearing Member failure, balance on client transaction account
is not part of general pool – it is:
–

Client money is pooled on firm failure
Inconsistent with transferring to back-up Clearing Member
Ported to back-up Clearing Member
Returned to Client
Returned to Clearing Member
Client may lose its client money regime protection if back-up
Clearing Member is not subject to CASS
Clearing Member discharges client money responsibilities if
What about title transfer?




EMIR should not prevent the use of title transfer collateral
arrangements between a Clearing Member and Client or Clearing
Member and CCP
EMIR will require Clearing Members to offer choice of omnibus or
individual segregation even if business is done on a title transfer
basis
Clearing Members will need to have separate client transaction
accounts at a CCP for positions held for its title transfer Clients
and those held for any client money Clients
If the firm becomes insolvent then when this money is returned by
the CCP it is not client money for the purposes of CASS but, in
accordance with EMIR, must be held by the firm for the account of
its Clients
Consequences of Clearing Member default
CCP:
1. Port
positions
and
margin
2. Return balance
to Client
Individual client
account
Defaulting
CM:
Defaulting
CM:
Client:
Client
money
Not part of
notional pool
3. Return balance to
defaulting Clearing
Member
Omnibus
client account
Notional client
money pool
Not Client
money
‘For account of
clients’?
Full sum minus costs
Sum rateable to client money entitlement
Sub-pools idea for EMIR

Consultation period just closed
–








Feedback expected first half 2013
Objective is to facilitate porting in net margin omnibus client accounts
Porting will require clients to double margin to cover back-up CM’s
exposure to each of them
On Clearing Member default, there may be client money at Clearing
Member level that would facilitate porting but which will be pooled
Firms could keep client money that relates to such an account but is not
passed on to a CCP in a separate pool, which is used to facilitate porting
on firm’s default
Pre-default, CASS applies separately to each sub-pool and to general
pool (eg. segregation, reconciliations, diversification obligations)
On default, client money can be transferred to a CCP or back-up
Clearing Member
Optional
Advantages and disadvantages
Sub-pools for EMIR
From FSA CP 12/22
Requirements for sub-pools



Notify FSA 3 months ahead of establishing, amending and
merging
Sub-pool terms – to identify beneficiaries and where client money
is held
Disclosure document – to make Clients aware of risks arising from
pool and other Clients sharing in it
– Description of purpose, whether Clients are retail or not, business line to which
it relates, advantages and risks to which Clients are exposed, how firm expects
sub-pool to be distributed on failure, how beneficiaries can be identified,
statement that beneficiary of pool will have no claim or interest to any other
pool unless it is also a beneficiary of that other pool and (if relevant) statement
that sub-pool is intended to facilitate porting
– Provide to Client and get written acknowledgement and consent
– Provide copy on Client’s request and give 3 months notice of material
amendments and mergers, allowing Client to terminate relationship

Provide sub-pool terms and disclosure document to FSA on
request
Possible introduction of sub-pools for wider purposes



FSA asking whether it should roll out sub-pools for other investment
businesses
Could allow firms to decide whether and how many sub-pools
FSA recognises firms may get more benefit from creating bespoke
arrangements
– Operating multiple pools will be costly and not all firms and clients will see
benefits in segregating along different lines
– But potential lack of incentive given costs

Could mandate segregation: Retail v non-retail clients
– Retail cash would not be exposed to risks taken by wholesale Clients and may
allow more rapid distribution from retail pool as fewer contentious issues

Margined v non-margined
– Volatile trades so riskier and likely to be more contentious issues

Alternatively, FSA could incentivise use of sub-pools by requiring firms to
make Clients aware of risks with general client money pools and subpool options on the market
Sub-pools for wider use
From FSA CP 12/22
Wider CASS review: Achieving better results
• Discussion paper on wider review
– FSA aims to produce consultation paper in first half 2013
• Objectives:
– Improve speed of return
– Reduce market impact of insolvency
– Achieve greater return of assets
• Review of special administration regime and broader issues arising from
MF Global being undertaken by government in parallel
• Current regime prioritises accuracy over speed – FSA questions whether
this is right balance
• Should it be different for retail and wholesale Clients?
• Wider review will also cover matters raised in supervisory work:
– Banking exemption
– Alternative approach
– Trust letters
Wider CASS review: FSA’s ideas
Achieving greater returns



Require firms to hold a buffer in client
bank accounts OR seek private sector
mutual insurance
An alternative approach requiring firms
to hold an equivalent amount to the
approximation of the monies at risk in
house accounts in client bank
accounts
Prioritising certain categories of
Clients
Speed of return





Reducing market impact

• Dislocate primary pooling event and
firm failure to provide option of selling
business rather than immediate pooling

• Get Client’s pre-consent to transfer
their assets
Regular Client statements detailing
balances and any right of use
Placing more emphasis on the firm’s
records of account segregation
Limiting use of exclusions or requiring
greater transparency
Establishing lock-in or cooling off
periods to reduce switching in days
leading up to failure
Incentivise operating via mandates
Insolvency practitioners liquidating all
assets and shortfall shared equally
Looking at inappropriate use of term
deposits by some firms
Other changes to CASS: The mandate rules

Clarifies mandate rules:
–
–
–

Any means which a firm obtains in written form from (and with the
consent of) the Client and subsequently retains, and which gives
the firm the ability (without the client’s further involvement being
necessary) to control the client’s assets or liabilities by:
–
–
–
–
•


Do not apply where firm holds client money or assets
Do not apply to operator of regulated collective investment scheme
Do not affect duties of another firm that holds client money or assets
Giving instructions to another person who holds an account for the Client
Giving instructions to another person who is responsible for holding the Client’s
money
Giving instructions to another person who is responsible for holding the Client’s
assets
Giving instructions to another person so that the Client incurs a debt or other
liability
Confirms that firm must establish and maintain adequate records
and internal controls in respect of its use of mandates
Other changes to detail of CASS and CMAR
Classification and oversight does not apply to firms that only
Impact on trading structures
Brokerage structures
• Ultimate trade obligations
• Initial trade obligations
• Means of getting trade
executed
Sponsored and
Naked Access
CCP
Exchange
Direct Electronic/
Market Access
Executing
Broker
Introducing/Agency
Broker
Give-up Agreement
Client
Clearing
Broker
Trading venues
Regulated
Markets (RMs)
- Non-discretionary
execution of transactions
- Managed by market
operator
-Operating is not an investment
activity or service
Systems that bring together third party
trading interests and result in
contracts
Multilateral Trading
Facilities (MTFs)
- Non-discretionary
execution of transactions
- Operating is an investment
service but can be operated by
market operators
- Few conduct of business rules apply
Organised Trading
Facilities (OTFs)
(Commission proposal)
- Discretion over
execution of
transactions
- Investor protection, conduct
of business and best execution requirements
- Cannot trade against proprietary capital
- Operating is an investment service
but can be operated by market operator
Organised Trading Facilities (OTFs)
• Broadly defined: all types of organised execution and arranging of trading which does not correspond to
RM or MTF
• Includes:
– Broker crossing systems which execute client orders against other client orders
– Systems eligible for trading clearing-eligible and sufficiently liquid derivatives
• Does not include:
– Facilities where there is no genuine trade execution or arranging taking place in the system, such as
bulletin boards, entities aggregating or pooling potential interests or electronic post-trade confirmation
• There are two different levels of discretion:
– When deciding to place an order on the OTF or to retract it again
– When deciding if, when and how much of two or more client orders it wants to match within the OTF
• Text now clarifies distinction between multilateral and bilateral systems
• Parliament proposed to limit to bonds, structured finance, emissions allowances and derivatives and
Council has followed
• Clarification that simultaneous matched principal trading is permitted subject to strong conflicts
management – UK govt agrees
• Council text is more restrictive on what is permitted:
– Prior express consent of Client needed
– Not derivatives declared subject to mandatory trading
No more OTC derivatives trading?
Mandatory on-platform trading for derivatives
G20 commitment to have all standardised OTC derivatives traded on exchanges or electronic platforms
Derivatives that are subject to clearing obligation in EMIR which:
– Are traded on at least one RM, MTF or OTF
– Are considered sufficiently liquid to only trade on these venues
ESMA also has an own initiative power to identify derivatives for this purpose: Unclear whether this
allows ESMA to include instruments which are not CCP cleared but this appears so
Must be traded on a RM, MTF, OTF or certain third country trading venues which Commission deems to
be equivalent and where third country provides equivalent recognition for EU trading platforms
Same scope as EMIR in relation to counterparties:
– Trades between financial counterparties and in-scope non-financial counterparties
– Trades between an EU captured entity and third country entities that would be subject to EMIR
– Trades between third country entities that would be subject to EMIR if they were established in the
EU where their transactions could have a direct, substantial and foreseeable effect within EU and
this is necessary to avoid evasion
– Excludes certain intra-group transactions
Algorithmic trading and direct electronic access
•Parliament amendments:
– Now a definition of high frequency trading
and sponsored and naked market access
– Firms using a high frequency trading strategy
must store raw audit trail of any quotation
and trading activities performed on any
trading venue
– Market makers must enter into a written
agreement with the trading venue including
terms and conditions on liquidity provision
– Investment firms shall not provide sponsored
and naked market access to a trading venue
– Even more requirements on platforms for
systems resilience, circuit breakers and
electronic trading
•
–
–
Points to note
Many of these provisions reflect ESMA
Guidelines which are already effective
UK govt thinks more evidence of impact is
needed and is concerned about requirement
to provide liquidity at all times
•
–
–
–
–
Council amendments:
New high frequency algorithmic trading
definition
Market making need only be carried out
during a specified portion of venue’s trading
hours except under exceptional
circumstances.
Market making firms shall take into account
sound operational, commercial and risk
management practices, as well as liquidity,
scale and nature of specific market and the
characteristics of instruments traded
New provisions for firms that engage in
algorithmic trading pursuant to a market
making strategy
–
I.e. a strategy, when dealing on own account,
that involves porting firm, simultaneous two-way
quotes of comparable size and at competitive
prices relating to one or more financial
instruments on a single trading venue or across
different trading venues, with the result of
providing liquidity on a regular and frequent
basis to the overall market
Pegasus: MiFID
OTC Oracle: EMIR
Disclaimer
The purpose of this presentation is to provide information as to developments in
the law. It does not contain a full analysis of the law nor does it constitute an
opinion of NRLLP on the points of law discussed.
No individual who is a member, partner, shareholder, director, employee or
consultant of, in or to any constituent part of Norton Rose Group (whether or not
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has any liability, to any person in respect of this presentation. Any reference to a
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