Response to joint Consultation on draft RTS on risk-mitigation techniques for OTC-derivative contracts not cleared by a CCP
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1. 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.
The major issue related to the new regulation is the application of the threshold of EUR 50 mln at the level of the consolidated group based on all non-centrally cleared derivatives between the two consolidated groups. This gives rise to operational issues in respect of how to split the overall threshold among different legal entities within the group and how this should be drafted in the CSA itself due to the fact that IM is calculated and settled at local level. As a result, this requirement would operationally be very difficult to manage.
Other potential issues are highlighted below:
- The chosen method for IM calculation: in case counterparties apply different IM calculation models, potential disputes can arise. To provide a remedy, regulators may consider the obligation to have counterparties agreeing on the appointment of one IM calculation agent (for instance, if a counterparty is subject to internal model methods (“IMM“) for IM calculation, the other counterparty can also benefit" from this calculation if there is one appointed "calculation agent").
That means that the calculation agent is responsible for all covered entities of the counterparty group in the event that it acts as the main entity with whom the counterparty does business.
- The use of IMM could in itself lead to issues in case the “calculation agent” counterparty has the need to recalibrate models or change methodologies: in fact, a recalibration or change of a model by a bank could be perceived as a unilateral change under a bilateral agreement which could be challenged by the other counterparty. A bank’s ability to upgrade / change models could be therefore negatively impacted. A possible solution could be that IMM counterparty has to give full disclosure of the change but no agreement by the other counterparty needs to be requested.
- Issues can also be highlighted within different legal entities of the same group: the calculation model can be different at legal entity level in order to avoid huge investments for the relatively smaller legal entity of a Group subject to the new Regulation or a "calculation agent" within the Group can be appointed.
- A possibility for a covered entity to decide upon a model per asset class (either standardized or internal model) coupled with the proposal in the underlying RTS draft, “If an internal model ceases to comply with regulatory requirements internal processes shall be flexible enough to allow for changing from an internal to a standardized model” increases complexity. Besides the required processes to be established internally, there is a need for strong alignment with the counterparty. Both internal and external processes are resource-intensive and increase the risk of having disputes.
- As the definition of MTA is applied to the sum of IM and VM, this introduces more complexity at an operational level. This is due to the fact that IM has to be compared at a group level for calculating thresholds, but the net amount of IM and VM has to be taken into account at the legal entity level for purposes of the MTA application. This complexity can lead to disputes. Considering the different meaning of single MTA components we recommend to have different MTA for IM and for VM respectively.
- The regulation should also specify in which way the status of the covered entity should be publicly disclosed to the market and how the average notional thresholds can be monitored.
- Collection of IM and VM should be subject to the standard settlement cycle; it cannot be daily if e.g. securities settle at T+2.
- Segregation of IM and delivery of collateral in case of default has to take into account internal processes of third party custodians; therefore “immediate” delivery of collateral should be revised by the regulator.
- There will be additional impacts on internal processes, mainly on concentration limits monitoring and application of IRB on the rating side: we would also expect that more disputes need to be managed."
1. 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?
The adoption of counterparty IRB models may likely lead parties to have IRB models which differ significantly from each other, especially when influenced by their own local regulatory frameworks/requirements. Hence disputes may arise due to these many differing models. In saying that, UniCredit recognises that the IRB rating models are subject to supervisory assessment for approval and the regulatory authorisation requires comprehensive information to be provided and the transparency and reliability principles to be satisfied. This may ensure appropriate transparency and demonstrate adequate understanding to supervisory authorities while also ensuring access to disclosure and reliability.
1. How will market participants be able to ensure the fulfillment of all the conditions for the reuse of initial margins as required in the BCBS-IOSCO framework?
It may be difficult to fulfill all the requirements.
In particular, major difficulties are related to: high costs of registering the collateral received as “reused”, the identification of counterparties permitted or not to re-use collateral, the difficulty in finding a “buy-side” counterparty with average notional above EUR 8 bln threshold. We in fact expects that the majority of counterparties subject to the regulation would be on the buy side as well on the sell side of a transaction, hence the possibility to re-use the initial margin would not apply.
If a Regulator wants to limit the re-use of IM received, it could allow a percentage of the received collateral to be reused in bilateral transactions, CCP postings or at least allow the re-use to Central Banks in order to permit banks to gather liquidity in case of need.
2. 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?
For cash collateral, every company would want to re-use it – if only to pay credit interest on collateral to the counterpart. Smaller dealers/banks that don’t trade OTC derivatives actively but do offer risk management solutions to their clients would also need to re-use collateral, especially to hedge their exposure to larger dealers.
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.
Question 21. 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.
The major issue related to the new regulation is the application of the threshold of EUR 50 mln at the level of the consolidated group based on all non-centrally cleared derivatives between the two consolidated groups. This gives rise to operational issues in respect of how to split the overall threshold among different legal entities within the group and how this should be drafted in the CSA itself due to the fact that IM is calculated and settled at local level. As a result, this requirement would operationally be very difficult to manage.
Other potential issues are highlighted below:
- The chosen method for IM calculation: in case counterparties apply different IM calculation models, potential disputes can arise. To provide a remedy, regulators may consider the obligation to have counterparties agreeing on the appointment of one IM calculation agent (for instance, if a counterparty is subject to internal model methods (“IMM“) for IM calculation, the other counterparty can also benefit" from this calculation if there is one appointed "calculation agent").
That means that the calculation agent is responsible for all covered entities of the counterparty group in the event that it acts as the main entity with whom the counterparty does business.
- The use of IMM could in itself lead to issues in case the “calculation agent” counterparty has the need to recalibrate models or change methodologies: in fact, a recalibration or change of a model by a bank could be perceived as a unilateral change under a bilateral agreement which could be challenged by the other counterparty. A bank’s ability to upgrade / change models could be therefore negatively impacted. A possible solution could be that IMM counterparty has to give full disclosure of the change but no agreement by the other counterparty needs to be requested.
- Issues can also be highlighted within different legal entities of the same group: the calculation model can be different at legal entity level in order to avoid huge investments for the relatively smaller legal entity of a Group subject to the new Regulation or a "calculation agent" within the Group can be appointed.
- A possibility for a covered entity to decide upon a model per asset class (either standardized or internal model) coupled with the proposal in the underlying RTS draft, “If an internal model ceases to comply with regulatory requirements internal processes shall be flexible enough to allow for changing from an internal to a standardized model” increases complexity. Besides the required processes to be established internally, there is a need for strong alignment with the counterparty. Both internal and external processes are resource-intensive and increase the risk of having disputes.
- As the definition of MTA is applied to the sum of IM and VM, this introduces more complexity at an operational level. This is due to the fact that IM has to be compared at a group level for calculating thresholds, but the net amount of IM and VM has to be taken into account at the legal entity level for purposes of the MTA application. This complexity can lead to disputes. Considering the different meaning of single MTA components we recommend to have different MTA for IM and for VM respectively.
- The regulation should also specify in which way the status of the covered entity should be publicly disclosed to the market and how the average notional thresholds can be monitored.
- Collection of IM and VM should be subject to the standard settlement cycle; it cannot be daily if e.g. securities settle at T+2.
- Segregation of IM and delivery of collateral in case of default has to take into account internal processes of third party custodians; therefore “immediate” delivery of collateral should be revised by the regulator.
- There will be additional impacts on internal processes, mainly on concentration limits monitoring and application of IRB on the rating side: we would also expect that more disputes need to be managed."
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?
Question 41. 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?
The adoption of counterparty IRB models may likely lead parties to have IRB models which differ significantly from each other, especially when influenced by their own local regulatory frameworks/requirements. Hence disputes may arise due to these many differing models. In saying that, UniCredit recognises that the IRB rating models are subject to supervisory assessment for approval and the regulatory authorisation requires comprehensive information to be provided and the transparency and reliability principles to be satisfied. This may ensure appropriate transparency and demonstrate adequate understanding to supervisory authorities while also ensuring access to disclosure and reliability.
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?
Question 61. How will market participants be able to ensure the fulfillment of all the conditions for the reuse of initial margins as required in the BCBS-IOSCO framework?
It may be difficult to fulfill all the requirements.
In particular, major difficulties are related to: high costs of registering the collateral received as “reused”, the identification of counterparties permitted or not to re-use collateral, the difficulty in finding a “buy-side” counterparty with average notional above EUR 8 bln threshold. We in fact expects that the majority of counterparties subject to the regulation would be on the buy side as well on the sell side of a transaction, hence the possibility to re-use the initial margin would not apply.
If a Regulator wants to limit the re-use of IM received, it could allow a percentage of the received collateral to be reused in bilateral transactions, CCP postings or at least allow the re-use to Central Banks in order to permit banks to gather liquidity in case of need.
2. 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?
For cash collateral, every company would want to re-use it – if only to pay credit interest on collateral to the counterpart. Smaller dealers/banks that don’t trade OTC derivatives actively but do offer risk management solutions to their clients would also need to re-use collateral, especially to hedge their exposure to larger dealers.