Response to consultations on guidelines on payment commitments
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Given the complexity of collateral management and the need to ensure that collateral is controlled by an independent third party to protect the interests of the credit institution and the DGSs, our strong view is that it is essential for the security of the DGSs that the collateral manager and custodian be able to hold the collateral in a sound and secure legal and operational environment. See our answer to Question 5 for more details on this point.
We recommend that paragraph 11(e) of the Draft Guidelines is amended to reflect that:
• one or more Financial Collateral Arrangements may support a Payment Commitment Arrangement;
• a custodian/collateral manager may be a party to a Financial Collateral Arrangement as defined (for example, the custodian will be a party to a triparty collateral management agreement, in addition to the credit institution and the DGS); and
• for the purposes of the Guidelines, the usual rights and security interests of a custodian or intermediary should not be considered to be a “third-party right” (for the reasons described in our Executive Summary).
We suggest some drafting in Annex 2 of our letter of 19 December 2014 (which we have submitted via the consultation form on the EBA website).
However, our view is that Title Transfer is a far preferable means for the management of collateral where there is an effective interposition of a triparty collateral manager. This is a specialist activity that involves collateral eligibility monitoring within agreed guidelines, intraday and daily marketing to market, margin calls, concentration limit management, processing of collateral substitutions requested by the credit institution (within collateral guidelines agreed between the DGSs and credit institutions) and substitutions necessary to process and protect corporate events such as dividends and rights issues.
The triparty collateral manager model is a specialised business which facilitates groups such as “credit institutions” delivering eligible collateral to the collateral manager, in excess of the Payment Commitment Amount. The excess is held in what we term the “Dealer Box” (which is a custody account established for the collateral provider and from which allocations of collateral are allocated), and would only be allocated to the DGSs or the secured party under precise terms such as eligibility requirements, margin calls and substitutions. Otherwise the excess collateral remained held for the collateral provider by the collateral manager in the Dealer Box, and because of its ready availability, margin calls and substitutions can be processed immediately without the standard “bilateral” market settlement timeframes which may involve days of delays, with all of the attendant risks of such an arrangement. In particular, the triparty collateral manager model enables continuous intra-day movements of collateral, thus optimising the allocation of collateral.
We refer to our answer for Question 2, where we state that one or more Financial Collateral Arrangements may support a Payment Commitment Arrangement, so there should be flexibility in this regard.
In regard to Part 3 of the draft Guidelines, we would recommend that paragraph 12(b) is amended to enable the credit institution to dispose of the collateral with the prior consent of the DGS. We have suggested some drafting in Annex 2 of our letter of 19 December 2014.
In regard to Part 4 of the draft Guidelines, BNY Mellon recommends a number of changes to paragraphs 14 and 15. We have suggested some drafting in Annex 2 of our letter of 19 December 2014.
We recommend that the draft Guidelines are amended to clarify that the collateral manager/custodian should not be a related entity to the credit institution providing the collateral. This is in order to reduce correlation between the circumstances of the credit institution and the custodian. We think this is an appropriate additional requirement.
We recommend that paragraph 15 is amended so that the expression “full segregation” is not used. Instead, we propose some alternative drafting in Annex 2 of our letter of 19 December 2014.
We do not support any interpretation that requires “full segregation” throughout the chain of custody, if this means that the interest of the particular credit institution or DGS must be noted at higher levels in the custody chain, such as each sub-custodian or CSD. We believe that such an approach is unworkable from an operational perspective in the context of collateral management (especially triparty collateral management), because beneficial ownership of collateral may change frequently (including intra-day) and it is not feasible for records to be constantly updated and synchronised at every level in the chain of custody. Nor is this required from a legal perspective, as the omnibus account structure is fully effective from a legal perspective and safeguards the interests of the ultimate beneficial owner of the asset. The ability to use omnibus account structures should be preserved. BNY Mellon can provide the EBA with more detailed information on the “full segregation” issues, should the EBA think this will be helpful.
We recommend that paragraph 14(a) is amended to refer to “record” rather than “information”, as it is not the role of the custodian to provide “information” which could have a broader interpretation than “records”.
As stated elsewhere in this response, the collateral manager’s/custodian’s usual rights and securities interests should be maintained, and therefore we recommend some amendments to paragraphs 14(a) and 14(b) of the draft Guidance.
In respect of point (20) and (21), we would suggest that if smaller institutions are unable to support the collateral diversity and exposure limits anticipated by the DGSs, that the haircut applied to their collateral contribution be higher than that for the larger institutions, who are able to support the diversity and exposure requirements.
In regard to Part 5 of the draft Guidelines, BNY Mellon recommends that the drafting is amended in order to maintain the collateral manager’s/custodian’s usual rights and security interests in unallocated collateral when providing custody and collateral management services. We have suggested some drafting in Annex 2 of our letter of 19 December 2014.
We believe the policy intent is for the Low-Risk Assets to be unencumbered at the point in time they are placed into custody, and for such Low-Risk Assets that are allocated to the DGS to be made available to the DGS upon request; but not to override the usual rights and security interests that a collateral manager/custodian has in regard to unallocated (excess) collateral, when performing custody and collateral management services.
provide the highest standards of care for the DGSs. In times of crisis, collateral values may move significantly and the need for additional collateral based on intra-day marking may be a valuable protection for the DGSs.
Question 2: Do you agree with these provisions to be included in Payment Commitment Arrangements? Do you think other provisions should be provided?
BNY Mellon is generally supportive of the requirements set out in Part 2 of the draft Guidelines. We have the following additional observations and recommendations.Given the complexity of collateral management and the need to ensure that collateral is controlled by an independent third party to protect the interests of the credit institution and the DGSs, our strong view is that it is essential for the security of the DGSs that the collateral manager and custodian be able to hold the collateral in a sound and secure legal and operational environment. See our answer to Question 5 for more details on this point.
We recommend that paragraph 11(e) of the Draft Guidelines is amended to reflect that:
• one or more Financial Collateral Arrangements may support a Payment Commitment Arrangement;
• a custodian/collateral manager may be a party to a Financial Collateral Arrangement as defined (for example, the custodian will be a party to a triparty collateral management agreement, in addition to the credit institution and the DGS); and
• for the purposes of the Guidelines, the usual rights and security interests of a custodian or intermediary should not be considered to be a “third-party right” (for the reasons described in our Executive Summary).
We suggest some drafting in Annex 2 of our letter of 19 December 2014 (which we have submitted via the consultation form on the EBA website).
Question 4: Do you agree with the option left to the DGS to enter into a Security Financial Collateral Arrangement (full ownership remains with the credit institution) or a Title Transfer Financial Collateral Arrangement (full transfer of ownership)?
BNY Mellon is supportive of the option left to the DGS to enter into a Security Financial Collateral Arrangement or a Title Transfer Financial Collateral Arrangement, ie, both options should be available.However, our view is that Title Transfer is a far preferable means for the management of collateral where there is an effective interposition of a triparty collateral manager. This is a specialist activity that involves collateral eligibility monitoring within agreed guidelines, intraday and daily marketing to market, margin calls, concentration limit management, processing of collateral substitutions requested by the credit institution (within collateral guidelines agreed between the DGSs and credit institutions) and substitutions necessary to process and protect corporate events such as dividends and rights issues.
The triparty collateral manager model is a specialised business which facilitates groups such as “credit institutions” delivering eligible collateral to the collateral manager, in excess of the Payment Commitment Amount. The excess is held in what we term the “Dealer Box” (which is a custody account established for the collateral provider and from which allocations of collateral are allocated), and would only be allocated to the DGSs or the secured party under precise terms such as eligibility requirements, margin calls and substitutions. Otherwise the excess collateral remained held for the collateral provider by the collateral manager in the Dealer Box, and because of its ready availability, margin calls and substitutions can be processed immediately without the standard “bilateral” market settlement timeframes which may involve days of delays, with all of the attendant risks of such an arrangement. In particular, the triparty collateral manager model enables continuous intra-day movements of collateral, thus optimising the allocation of collateral.
We refer to our answer for Question 2, where we state that one or more Financial Collateral Arrangements may support a Payment Commitment Arrangement, so there should be flexibility in this regard.
In regard to Part 3 of the draft Guidelines, we would recommend that paragraph 12(b) is amended to enable the credit institution to dispose of the collateral with the prior consent of the DGS. We have suggested some drafting in Annex 2 of our letter of 19 December 2014.
Question 5: Do you think other requirements about the choice of the custodians should be provided under these guidelines?
As addressed in our response to Question 4, we believe that for something as significantly important to the stability of the financial markets in times of market or credit institution failure, it is essential that an organisation is appointed which is capable of adequately protecting collateral and correctly administering the process of release of the collateral to the DGSs, for example. We believe that the criteria for the choice of a custodian/collateral manager should be primarily based on considerations of legal protection and service.In regard to Part 4 of the draft Guidelines, BNY Mellon recommends a number of changes to paragraphs 14 and 15. We have suggested some drafting in Annex 2 of our letter of 19 December 2014.
We recommend that the draft Guidelines are amended to clarify that the collateral manager/custodian should not be a related entity to the credit institution providing the collateral. This is in order to reduce correlation between the circumstances of the credit institution and the custodian. We think this is an appropriate additional requirement.
We recommend that paragraph 15 is amended so that the expression “full segregation” is not used. Instead, we propose some alternative drafting in Annex 2 of our letter of 19 December 2014.
We do not support any interpretation that requires “full segregation” throughout the chain of custody, if this means that the interest of the particular credit institution or DGS must be noted at higher levels in the custody chain, such as each sub-custodian or CSD. We believe that such an approach is unworkable from an operational perspective in the context of collateral management (especially triparty collateral management), because beneficial ownership of collateral may change frequently (including intra-day) and it is not feasible for records to be constantly updated and synchronised at every level in the chain of custody. Nor is this required from a legal perspective, as the omnibus account structure is fully effective from a legal perspective and safeguards the interests of the ultimate beneficial owner of the asset. The ability to use omnibus account structures should be preserved. BNY Mellon can provide the EBA with more detailed information on the “full segregation” issues, should the EBA think this will be helpful.
We recommend that paragraph 14(a) is amended to refer to “record” rather than “information”, as it is not the role of the custodian to provide “information” which could have a broader interpretation than “records”.
As stated elsewhere in this response, the collateral manager’s/custodian’s usual rights and securities interests should be maintained, and therefore we recommend some amendments to paragraphs 14(a) and 14(b) of the draft Guidance.
Question 6: Do you agree on the requirements suggested for the eligibility of collateral? Would you suggest other limits on concentration in exposures?
The point raised in (19) is critically important, in that any failure on the part of the DGS to develop a robust and risk protective collateral schedule, will have implications for the DGS and its beneficiaries. In that respect, the definition of the Low-Risk Assets will need to be cognisant of asset type, currency, concentration, liquidity and correlation risk.In respect of point (20) and (21), we would suggest that if smaller institutions are unable to support the collateral diversity and exposure limits anticipated by the DGSs, that the haircut applied to their collateral contribution be higher than that for the larger institutions, who are able to support the diversity and exposure requirements.
In regard to Part 5 of the draft Guidelines, BNY Mellon recommends that the drafting is amended in order to maintain the collateral manager’s/custodian’s usual rights and security interests in unallocated collateral when providing custody and collateral management services. We have suggested some drafting in Annex 2 of our letter of 19 December 2014.
We believe the policy intent is for the Low-Risk Assets to be unencumbered at the point in time they are placed into custody, and for such Low-Risk Assets that are allocated to the DGS to be made available to the DGS upon request; but not to override the usual rights and security interests that a collateral manager/custodian has in regard to unallocated (excess) collateral, when performing custody and collateral management services.
Question 9: Do you agree with the criteria on the eligibility of the collateral provided in this Part 6? Do you think other requirements should be provided in these guidelines on this issue?
Our responses above address this question, in particular Question 6. Also, we would emphasise that it is important to distinguish between Low-Risk Assets that are allocated to the DGS, versus the unallocated (excess) collateral which are not allocated to the DGS at that time, but can be allocated to it in future. The collateral manager should have a security interest in the unallocated collateral, but not in the collateral allocated to the DGS.Question 10: Do you agree with the criteria on the haircut provided in this Part 7? Do you think there are other requirements which should be provided under these guidelines about this issue?
We agree with the direction of the comments in this section. However, we would strongly advocate that policy in terms of marking to market be established in order to 6provide the highest standards of care for the DGSs. In times of crisis, collateral values may move significantly and the need for additional collateral based on intra-day marking may be a valuable protection for the DGSs.