Second Consultation paper on the draft regulatory
technical standards on risk-mitigation techniques for
OTC-derivative contracts not cleared by a CCP
under Article 11(15) of Regulation (EU) No 648/2012
18 June 2015, London
Content
 International and legal framework
 Mandate
 Structure of the draft RTS
 References
 Annex
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Introduction
 The scope of these draft RTS Regulation covers banks, investment firms,
insurance companies , alternative investment fund managers and non-financial
counterparties that are considered systemically important (i.e. above the clearing
threshold)
 For this reason, the Legislators mandated the ESAs to work together developing
a joint draft RTS
 In the broader effort of the derivatives reform, the EMIR and these draft RTS
implement the international agreed principles (BCBS-IOSCO framework) in the
European Union. These principles were issued on September 2013, and
reviewed in March 2015
 These draft RTS further specify aspects, requirements and processes that the
BCBS-IOSCO framework left open to local implementation
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International and legal framework
The two main references:
 Regulation (Eu) No 648/2012 of the European Parliament and of the
Council of 4 July 2012 on OTC derivatives, central counterparties and
trade repositories (EMIR)
 Margin requirements for non-centrally cleared derivatives, issued by
BCBS and IOSCO on September 2013 and reviewed on March 2015
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Next steps

10 July 2015
End of second consultation

September/October
ESAs to submit the final draft RTS to
the European Commission (expected)

Immediately
after publication
in the Official Journal
of the EU
Application of the provisions related to
intragroup exemptions

1 September 2016
Application of the risk management
procedures (including the requirement
to collect collateral) in the modalities set
by these RTS

New phase-in
Phase-in of the requirements for VM
and IM in line with the updated BCBSIOSCO framework
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Structure of the draft RTS in the 2nd consultation paper
 Recitals
 Chapter 1
Counterparties’ risk management procedures
 Chapter 2
Procedures concerning the exemptions for
intragroup derivative contracts
 Chapter 3
Applicable criteria for applying
exemptions for intragroup derivative contracts
 Chapter 4
Final provisions
 Annexes
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Main changes from the first Consultation Paper
1. Treatment of non-EU non-financial counterparties (Art. 2 GEN)
2. Exchange of margins with third country entities (Art. 3 GEN)
3. Treatment of derivatives associated to covered bonds for hedging purposes (Art. 8
GEN)
4. Timing for the collection of variation margin (Art. 1 VM)
5. Requirements concerning initial margin models (Art. 1 – 5 MRM)
6. Alignment of minimum CQS for collateral between IRB and ECAI ratings (Art. 3 LEC)
7. Concentration limits (Art. 7 LEC)
8. Haircut for FX mismatch (Art. 1 HC and Annex II)
9. Trading documentation (Art. 2 OPD)
10. Re-use and re-hypothecation (treatment of cash collateral for IM) (Art. 1 REU)
11. Intragroup exemptions: definition of practical and legal impediments (Art. 3 and 4
IGT)
12. Amended IM and VM phase-in (Art. 1 FP)
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1) Treatment of non-EU non-financial counterparties (Art. 2 GEN)
 Third countries non-financial counterparties below the clearing threshold
(NFC-) should be treated as EU NFC The identification of the status of a non-financial counterparty and whether
that counterparty is above/below the clearing threshold is left to the European
Counterparty.
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2) Exchange of margins with third country entities (Art. 3 GEN) (1/2)
 In the first consultation paper, the RTS were developed on the concept that
EU counterparties are required to collect margins (‘collect only’)
 The implicit assumption was that the same entities that are in the scope of
the EMIR and BCBS-IOSCO framework would also be covered by the margin
rules in third countries.
 As this is not the case, the requirement for the EU counterparties to only
collect margins has been extended to also post margins.
 Art. 3 GEN “Where a counterparty referred to in Article 1(1) GEN, which is
established in the Union enters into a OTC derivative contract with a
counterparty that is established in a third country and would be subject
to the requirements of this Regulation if it was established in the Union,
the risk management procedures shall include that initial and variation margin
are exchanged between the counterparties and that the collateral is
maintained and protected, in accordance with this Regulation”.
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2) Exchange of margins with third country entities (Art. 3 GEN) (2/2)
 Exchange IM when dealing with third country counterparties, including the
requirement of posting IM to counterparties domiciled in non-netting
jurisdiction (i.e., where bankruptcy laws, netting and segregation agreements
are not enforceable)
 European counterparties have the obligation to assess the legal enforceability
of the netting and segregation agreements.
 Where this assessment turns out to be negative, counterparties will have to
rely on alternative arrangements
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3) Treatment of derivatives associated to covered bonds swaps for
hedging purposes (Art. 8 GEN)

At least in some jurisdictions, covered bond issuers/cover pools are not able to
collect IM because the resulting claim of the posting counterparty on the
collateral would be considered a claim ranking senior to the bond-holders

This special treatment is only available for covered bond programmes that fulfil
certain restrictions similar to those in the first Consultation Paper apply

Similar requirements were introduced to guarantee an exemption for covered
bonds swaps from clearing obligations in the RTS on Interest Rates derivatives

These requirements include the 2% regulatory over-collateralisation as
alternative to margin requirements.

The current proposal includes:


two-way exemption from IM; and

one-way exemption for the covered bond issuer/cover pool from posting VM
The covered bond issuers/cover pools would be required to collect VM and
required to return the cash VM previously collected
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Treatment of swaps related securitisation vehicles

No legal basis for introducing similar exemptions for SPVs

Many SPVs might be exempted anyway when classified as “NFC-”

However, as the clearing threshold works at group level, some of the SPVs classified
as NFC- might be captured (i.e. required to exchange margins) because of
consolidation requirements
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4) Timing for the collection of variation margin (Art. 1 VM) (1/2)
 As in the first Consultation Paper, the timing for the exchange of initial and
variation margin is set to ‘T+1’, i.e. the business day following the trade
date.
 Respondents to the first consultation noticed that:

real-world constraints, such as different time zones, might impede the
implementation of this requirement

portfolio reconciliation issues, time to settle cash payments or to transfer
securities may justify extending this time
 Completing the transfer at T+1 is considered a fundamental pillar of the whole
margin framework.
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4) Timing for the collection of variation margin (Art. 1 VM) (2/2)
 Flexibility in the time for the exchange of margins:

“T” might be subject to further specification in the final rules to allow for
time-zone differences to be taken into account

The current draft RTS allow that variation margins are not collected at
‘T+1’ as long as the margin period of risk for the calculation of the IM is
increased of a number of days equal to the extension

T+3 is only allowed for VM and under those conditions
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5) Requirements concerning initial margin models (Art. 1 – 5 MRM)
 The draft RTS includes detailed requirements for developing initial margin
models
 As in the first consultation paper:

main non-linearities have to be captured

collateral should be modelled as distinct from the OTC derivative
portfolio
 Different from first consultation paper:
 use of a ‘primary risk factor’ is dropped as the BCBS-IOSCO
requirement to avoid risk offsetting among asset classes can be achieved
in other ways
 correlations and basis risk have to be captured by a conservative
calibration
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6) Alignment of the CQS between IRB and ECAIs (Art. 3 LEC)
 In the current draft, the minimum credit quality level for collateral for
counterparties using IRB models and counterparties using ECAI ratings have
been aligned to CQS 3
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7) Concentration limits (Art. 7 LEC)
 Concentration limits: The ESAs have carefully considered this issue, and
concluded that the concentration limits are necessary to limit systemic risks.
Collateral diversification is also an explicit requirement of the BCBS-IOSCO
principle
 Current proposal:

concentration limits for non-sovereign debt securities apply to all
counterparties (by issuer and type)

concentration limits for sovereign debt securities (EU and non-EU) apply
only to systemically important counterparties:
• GSIIs
• OSIIs and
• those collecting (in a single netting set) more than EUR 1bn collateral

concentration limits (in a single netting set) for sovereign debt securities
(EU and non-EU) apply to collateral above EUR 1 bn
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8) Haircut for FX mismatch (Art. 1 HC and Annex II)
 The haircut for currency mismatch is maintained for IM and VM but
removed for VM posted in cash in any currency
 The reasoning behind this choice:

it would interfere with the current market practices and

the haircut on cash would increase the credit risk for the posting party, as
it would not be segregated and posted in excess to the change in market
value of the derivatives
 For VM posted in securities, the FX haircut and all the other haircuts apply in
line with the CRR volatility adjustments. In this case, the FX haircut for VM
has to be calculated with respect to the transfer currency
 The FX haircut for IM is calculated with respect to the termination currency
 Where transfer currency and/or termination currency are not foreseen in the
agreements, the FX haircut applies to the entire collateral for that netting set
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9) Trading documentation (Art. 2 OPD)
 Proper trading relationship documentation is required
 Legal assessment on the enforceability of the netting agreement and the
segregation requirements is also required
 Requiring all the market participants to have a legal opinion on all bilateral
agreements was considered excessively burdensome
 The requirements requiring a written agreement from non-covered
counterparties were dropped
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10) Re-use and re-hypothecation (treatment of cash collateral for initial
margin) (Art. 1 REU)
 Considering:

No intention of the ESAs to ban cash as eligible collateral for IM

Requirements on segregation of IM may clash with the actual possibility to
segregate cash

Cash for IM ‘un-economical’ and therefore use of cash for IM should be a
uncommon event
 In the current draft: initial margin collected in cash can be re-invested in
eligible collateral as long as the collateral is used to secure the exposure
that the custodian or the collecting party has with respect to the posting party
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11) Intragroup exemptions: practical and legal impediments (Art. 3 and 4
IGT) (1/2)
 Under the EMIR, intragroup transactions for non-centrally cleared OTC
derivatives are exempted from margin requirements as long as “there is no
current or foreseen practical or legal impediment to the prompt transfer of own
funds or repayment of liabilities between counterparties”
 The following current or foreseen restrictions have to be considered:

currency and exchange controls;

the regulatory, administrative, legal or contractual framework in which the
counterparties operate is such as to prevent mutual financial support or
significantly affect the transfer of funds within the group;

any of the conditions on the early intervention, recovery and resolution are
met, as a result of which the supervisor foresees an impediment to the
prompt transfer of own funds or repayment of liabilities;

the existence of minority interests that limit decision-making power within
entities that form the group;

the purpose or the legal structure of the counterparty undertaking, as
defined in its statutes, instruments of incorporation
rules.
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11) Intragroup exemptions: practical and legal impediments (Art. 3 and 4
IGT) (2/2)
 Current restrictions of a practical nature have to be considered including any
of the following:

Insufficient availability of unencumbered or liquid assets to the relevant
counterparty when due; or

there are operational obstacles for such transfers or repayments when
due
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12) Amended IM and VM phase-in (Art. 1 FP)
 A new phase-in for the margin requirements was issued by the BCBS and
IOSCO in March 2015
 The current draft RTS updates the timeline according to BCBS-IOSCO
framework
 The new date of implementation:

1 September 2016 for VM and IM for the major participants

VM is phased-in in the following six months and

IM is phased-in over the following four years
 To note that the permanent exemption from IM (EUR 8 bn) does not apply to
VM
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Most significant aspects unchanged from first consultation paper (1/2)




Definitions of Termination and Insolvency,
Definition of counterparty
Voluntary collateralisation
Scope of Coverage - Instruments Subject to the Requirements
 Novation and Portfolio Compression
 FX derivatives
 Others (non EU – CCP)
 Scope of Coverage – Counterparties
 UCITS and other Investment Funds
 IORPS
 Sovereigns, central banks and multilateral development banks (in Level 1)
 Microfinance, real estate and other specialised funds
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Most significant aspects unchanged from first consultation paper (2/2)








Operational Process for the exchange of collateral
EUR 8 bn notional threshold - Calculation and Implementation (redraft)
EUR 50 mln threshold (redraft)
Minimum Transfer Amount (redraft)
Collateral Eligibility - Wrong Way Risk
Haircuts
Standard Haircuts (clarification on currency mismatch)
Haircut models
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Annexes
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The mandate under Article 11(15) of the EMIR
Article 11(15)
“In
order
to
ensure
consistent
application of this Article, the ESAs shall
develop common draft regulatory
technical standards specifying:
(a) the risk - management procedures,
including the levels and type of
collateral
and
segregation
arrangements, required for compliance
with paragraph 3;
(b) the level of capital required for
compliance with paragraph 4; (1)
(c) the
procedures
for
the
counterparties and the relevant
competent authorities to be followed
when applying exemptions under
paragraphs 6 to 10;
(d) the applicable criteria referred to in
paragraphs 5 to 10 including in
particular what should be considered as
practical or legal impediment to the
prompt transfer of own funds and
repayment of liabilities between the
counterparties”.
(1)
As amended by Article 520 of the CRR
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References

Regulation (Eu) No 648/2012 of the European Parliament and of the Council of 4 July
2012 on OTC derivatives, central counterparties and trade repositories (EMIR) [link]

Consultation Paper: Draft regulatory technical standards on risk-mitigation techniques
for OTC-derivative contracts not cleared by a CCP under Article 11(15) of Regulation
(EU) No 648/2012 [link]

Joint Discussion Paper on Draft Regulatory Technical Standards on risk mitigation
techniques for OTC derivatives not cleared by a CCP under the EMIR (JC/DP/2012/1)
issued by EBA, EIOPA and ESMA on 6 March 2012 [link]

Margin requirements for non-centrally cleared derivatives – final document, issued by
BCBS and IOSCO on March 2015 [link]

Supervisory guidance for managing risks associated with the settlement of foreign
exchange transactions, issued by BCBS on February 2013 [link]
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