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 welcome the ESAs view that the threshold relevant for the question whether or not to exchange Initial Margin contributions needs to be considered for each investment fund or sub-fund (compartment) separately.
In some cases, the investor of an investment fund (AIF) wishes that more than one asset manager manages the investment fund. This is achieved by creating segments or portfolios (e.g. one segment concerning equities and another segment concerning non-equities) each managed by a certain asset manager.
Similarly, UCITS funds have the opportunity to create sub-funds / compartments that have segregated asset and liabilities from the fund or other sub-funds.
This is considered for collateralization reasons too. The collateral to be posted by the parties is determined with respect to each segment or the sub-fund separately.
In order to maintain the possibility for investors to have their investment fund managed by more than one asset manager or to avoid the creation of legal solidarity between sub-funds, it would be helpful if the ESAs would clarify in Recital 5 that in case of segmented investment funds, each segment should be considered as a distinct entity.
This question is even more crucial for funds with sub-funds as it would force each compartment to deliver initial margin.
Moreover, the fact that a client may have concluded several mandates with different asset managers brings additional difficulties in calculating margins. It is then not possible for the asset manager of one mandate to calculate the threshold or deliver the margins as the global exposure remains impossible to define.
2) Grand-fathering clause
We wish to insist on the necessity to fully and explicitly establish the fact that the regulation will only apply to transactions conducted after its implementation date.
It should not only be mentioned under recital 18 but also included in the text of the regulation itself. Furthermore, we consider that a clarification should be added to make sure that “genuine amendments” as referred to in the BCBS/IOSCO final report (§ 8.9 and footnote 20, p. 24) made to existing derivative contracts shall not be in the scope of the new regulation. An explicit mention in article 1 FP § 4 would bring the necessary clarification.
3) Eligible collateral
The eligible collateral should not be limited to the list of the main indices. Eligible collateral list should be extended to other indices as well.
The RTS should also provide an assessment method for the calculation of haircuts on equities.
As far as we understand, the application of two different methods by the parties to evaluate and calculate haircuts may result in discrepancies and we see no procedure in the RTS to solve those discrepancies.
4) Ban of re-use of initial margin
We would like to highlight that as per the “Guidelines on ETFs and other UCITS issues” published by ESMA on the 18th December 2012, a UCITS is bound to invest the cash collateral it receives. Therefore, banning the re-use of cash received as initial margin is in contradiction with other guidelines and rules imposed to UCITS funds.
Cash collateral should be placed on deposits, invested on high quality investment bonds, used for the purpose of reverse repo or invested in short term money market funds. Such investments must be in compliance with additional security constraints. We consider this regime adequately secures transactions and avoid risk in case of default of the receiving party.
5) Post capital or hold assets
Complying with the cover rule (Art. 51 para. 3 of Directive 2009/65/EC) should be recognized as equivalent to holding own capital. According to Recital 3, a counterparty shall have the choice either to post / collect (initial) margins or holding own capital if the amount of initial margin is below the threshold.
UCITS investment funds are subject to the cover rule (cf. Art. 51 para. 3 of Directive 2009/65/EC as well as CESR consultation 10-108). A UCITS shall ensure that its global exposure relating to derivative instruments does not exceed the total net value of its portfolio.
In order to avoid any misinterpretation, the ESAs should clarify in Recital 3 that in case of investment funds, complying with the cover rule is an equivalent to holding own capital.
6) Conflict in diversification rules
There are some contradiction between diversification limits resulting from the application of article 7 LEC of the RTS (pages 38-39) and the concentration limits resulting from the ESMA Guidelines on ETFs and other UCITS issues.
The proposed regulation refers to the total amount of the collateral when computing the diversification ratio. It is inconsistent to consider that there is a risk on the collateral of small amount that could be mitigated with a diversification rule; it is not workable to ask counterparties to split small amounts of collateral on several issues for even smaller amounts, uneasy to manage and costly to transfer. Indeed, regarding a fund, the denominator of the ratio is what is important in the fund, i.e. the net asset value or the net capital available in the fund.
The harmonization within each Member State as regards those concentration limits in UCITS implementation and in EMIR is a necessary pre-requisite to improve legal certainty, liquidity as well as the level playing field between market players.
If concentration rules were to apply, we strongly suggest that there should be a realistic threshold under which they should not, simply because it is not workable to ask for a split over different issuers of collateral on smaller amounts than 100 million EUR.
7) IM Calculation Method
From an asset managers’ viewpoint, we believe that a standardized margin schedule should be the preferred approach, which would lessen the risk of disputes as compared to quantitative portfolio models developed by counterparties.
8) Different MTA for IM and VM
The proposed regulation suggests a Minimum Transfer Amount (MTA) of 500 000 €. This amount includes the net variation of IM and VM exchanged between 2 counterparties.
We would prefer to have two MTAs. We hence suggest to follow two MTAs of at least 250 000 € each instead of one of 500 000€.
For both the IRB model (eligible collateral and haircut) and the internal model of Initial Margin calculation, small and medium size player will be exposed to non-transparent models.
We are of the opinion that BCBS/IOSCO principles have taken a prudent and pragmatic approach when strongly limiting the possibility to re-use or re-hypothecate received collateral. We think that there is no reason not to follow these principles. OTC derivatives are traded between professionals. If counterparty agrees that the re-use of collateral will be positive and made for the benefit of its clients, re-use should not be prohibited.
An example of circumstances where re-use will be helpful is to be found in the case of back to back transactions where a counterparty A manages the exposition it took from a derivative contract with a fund through a reverse transaction with counterparty B; the collateral received from the fund by A may be re-used and posted in favour of B that finally takes the market risk. All the more if A is a financial institution that provides the fund with a guarantee.
The required prior explicit approval by the poster of the collateral (transaction by transaction), the fact that it can check that the re-use is made in conjunction with a further transaction aiming at managing the risk initially taken from the fund and not to take further exposure, the possibility to earmark the collateral…all is made to limit the re-use to a very few cases when professionals fully agree.
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.
1) Impossibility to calculate exposuresWe welcome the ESAs view that the threshold relevant for the question whether or not to exchange Initial Margin contributions needs to be considered for each investment fund or sub-fund (compartment) separately.
In some cases, the investor of an investment fund (AIF) wishes that more than one asset manager manages the investment fund. This is achieved by creating segments or portfolios (e.g. one segment concerning equities and another segment concerning non-equities) each managed by a certain asset manager.
Similarly, UCITS funds have the opportunity to create sub-funds / compartments that have segregated asset and liabilities from the fund or other sub-funds.
This is considered for collateralization reasons too. The collateral to be posted by the parties is determined with respect to each segment or the sub-fund separately.
In order to maintain the possibility for investors to have their investment fund managed by more than one asset manager or to avoid the creation of legal solidarity between sub-funds, it would be helpful if the ESAs would clarify in Recital 5 that in case of segmented investment funds, each segment should be considered as a distinct entity.
This question is even more crucial for funds with sub-funds as it would force each compartment to deliver initial margin.
Moreover, the fact that a client may have concluded several mandates with different asset managers brings additional difficulties in calculating margins. It is then not possible for the asset manager of one mandate to calculate the threshold or deliver the margins as the global exposure remains impossible to define.
2) Grand-fathering clause
We wish to insist on the necessity to fully and explicitly establish the fact that the regulation will only apply to transactions conducted after its implementation date.
It should not only be mentioned under recital 18 but also included in the text of the regulation itself. Furthermore, we consider that a clarification should be added to make sure that “genuine amendments” as referred to in the BCBS/IOSCO final report (§ 8.9 and footnote 20, p. 24) made to existing derivative contracts shall not be in the scope of the new regulation. An explicit mention in article 1 FP § 4 would bring the necessary clarification.
3) Eligible collateral
The eligible collateral should not be limited to the list of the main indices. Eligible collateral list should be extended to other indices as well.
The RTS should also provide an assessment method for the calculation of haircuts on equities.
As far as we understand, the application of two different methods by the parties to evaluate and calculate haircuts may result in discrepancies and we see no procedure in the RTS to solve those discrepancies.
4) Ban of re-use of initial margin
We would like to highlight that as per the “Guidelines on ETFs and other UCITS issues” published by ESMA on the 18th December 2012, a UCITS is bound to invest the cash collateral it receives. Therefore, banning the re-use of cash received as initial margin is in contradiction with other guidelines and rules imposed to UCITS funds.
Cash collateral should be placed on deposits, invested on high quality investment bonds, used for the purpose of reverse repo or invested in short term money market funds. Such investments must be in compliance with additional security constraints. We consider this regime adequately secures transactions and avoid risk in case of default of the receiving party.
5) Post capital or hold assets
Complying with the cover rule (Art. 51 para. 3 of Directive 2009/65/EC) should be recognized as equivalent to holding own capital. According to Recital 3, a counterparty shall have the choice either to post / collect (initial) margins or holding own capital if the amount of initial margin is below the threshold.
UCITS investment funds are subject to the cover rule (cf. Art. 51 para. 3 of Directive 2009/65/EC as well as CESR consultation 10-108). A UCITS shall ensure that its global exposure relating to derivative instruments does not exceed the total net value of its portfolio.
In order to avoid any misinterpretation, the ESAs should clarify in Recital 3 that in case of investment funds, complying with the cover rule is an equivalent to holding own capital.
6) Conflict in diversification rules
There are some contradiction between diversification limits resulting from the application of article 7 LEC of the RTS (pages 38-39) and the concentration limits resulting from the ESMA Guidelines on ETFs and other UCITS issues.
The proposed regulation refers to the total amount of the collateral when computing the diversification ratio. It is inconsistent to consider that there is a risk on the collateral of small amount that could be mitigated with a diversification rule; it is not workable to ask counterparties to split small amounts of collateral on several issues for even smaller amounts, uneasy to manage and costly to transfer. Indeed, regarding a fund, the denominator of the ratio is what is important in the fund, i.e. the net asset value or the net capital available in the fund.
The harmonization within each Member State as regards those concentration limits in UCITS implementation and in EMIR is a necessary pre-requisite to improve legal certainty, liquidity as well as the level playing field between market players.
If concentration rules were to apply, we strongly suggest that there should be a realistic threshold under which they should not, simply because it is not workable to ask for a split over different issuers of collateral on smaller amounts than 100 million EUR.
7) IM Calculation Method
From an asset managers’ viewpoint, we believe that a standardized margin schedule should be the preferred approach, which would lessen the risk of disputes as compared to quantitative portfolio models developed by counterparties.
8) Different MTA for IM and VM
The proposed regulation suggests a Minimum Transfer Amount (MTA) of 500 000 €. This amount includes the net variation of IM and VM exchanged between 2 counterparties.
We would prefer to have two MTAs. We hence suggest to follow two MTAs of at least 250 000 € each instead of one of 500 000€.
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 approve the requirement that banks communicate on the models that they use and the data that they take into account when running these models. From the perspective of the asset managers, our responsibility towards our clients includes the verification of the prices of the financial instruments that we use and the level of collateral is within the scope of our controls.For both the IRB model (eligible collateral and haircut) and the internal model of Initial Margin calculation, small and medium size player will be exposed to non-transparent models.
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?
We believe that the prohibition or authorization of re-use should not be determine on a regulatory level but on case by case basis within a bilateral agreement between the parties.We are of the opinion that BCBS/IOSCO principles have taken a prudent and pragmatic approach when strongly limiting the possibility to re-use or re-hypothecate received collateral. We think that there is no reason not to follow these principles. OTC derivatives are traded between professionals. If counterparty agrees that the re-use of collateral will be positive and made for the benefit of its clients, re-use should not be prohibited.
An example of circumstances where re-use will be helpful is to be found in the case of back to back transactions where a counterparty A manages the exposition it took from a derivative contract with a fund through a reverse transaction with counterparty B; the collateral received from the fund by A may be re-used and posted in favour of B that finally takes the market risk. All the more if A is a financial institution that provides the fund with a guarantee.
The required prior explicit approval by the poster of the collateral (transaction by transaction), the fact that it can check that the re-use is made in conjunction with a further transaction aiming at managing the risk initially taken from the fund and not to take further exposure, the possibility to earmark the collateral…all is made to limit the re-use to a very few cases when professionals fully agree.