Response to joint Consultation on draft RTS on risk-mitigation techniques for OTC-derivative contracts not cleared by a CCP
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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 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.
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.
Question 2. Are there particular aspects, for instance of an operational nature, that are not addressed in an appropriate manner? If yes, please provide the rationale for the concerns and potential solutions.
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.
Question 4. In respect of the use of a counterparty IRB model, are the counterparties confident that they will be able to access sufficient information to ensure appropriate transparency and to allow them to demonstrate an adequate understanding to their supervisory authority?
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.
Question 6. How will market participants be able to ensure the fulfilment of all the conditions for the reuse of initial margins as required in the BCBS-IOSCO framework? Can the respondents identify which companies in the EU would require reuse or re-hypothecation of collateral as an essential component of their business models?
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.