FFI appreciates the fact that proposed European standards mainly follow the proposals at the global level. Still, proposed collateral requirements will create administrative burden and costs to small and medium sized entities.
Any flexibility allowed in the global standards should be used and will help in minimizing the burden in the first place.
Large part of the costs will derive from the need to re-negotiate existing contracts and to document a lot of information.
To minimize the negative impact of these requirements the FFI proposes that the evaluation of several documents is done in the same period (i.e. regardless of the document, it should be reviewed e.g. yearly or every six months).
Operation of margin transfers will require more resources or reallocations of existing resources in smaller entities (which many European companies are). These costs are hard to quantify but the requirements will result in higher operational and funding costs. The same applies to diversification requirements which we urge to be redrafted by the ESAs. An example is suggested later in this response. In general, promotion of standardized third party solutions may reduce the operational burden and IT development costs.
Some of the costs of these requirements will touch upon the whole market. IM margin requirements are a change to the established market practise and will lead to higher costs for derivatives end users. Hence a risk exists that companies will not hedge their positions. This, in turn, is detrimental to the whole economy and the prevention of systemic risks.
The requirement for EU counterparties to collect margin from all entities regardless of their origin is problematic. This poses both business and regulatory challenges. Basically, third country entities do not belong to the traditional scope of EMIR. It seems challenging to ask those entities to not only post IM to their EU counterparty, but also to make the needed representation of their thresholds and classification under EMIR.
Due to the operational burden and additional costs of posting IM according to proposed rules, non-EU entities are less likely to trade with EU counterparties. This in turn would lead to further market fragmentation and disadvantage for the EU economy. Even more operational burden is caused by the fact that even NFC outside of EU would be required to post IM according to the current draft.
FFI urges ESAs to reconsider this requirement. IM should only be exchanged between counterparties that are in the scope of EMIR. Widening this obligation can be first considered when the extraterritoriality issues are finalized and in this respect, ESAs and the Commission should work towards consistency and alignment of requirements globally. This applies to the whole content of the requirements (thresholds, timing of the requirements, entities that will be in the scope of these rules, possible exemptions etc.).
We are pleased with the level of thresholds set in the draft rules. These are a great tool to ensure proportionality. Still it must be kept in mind that even in the case where one of the counterparties does not overcome the proposed thresholds and a need to exchange margin does not exist, a number of agreements need to be entered into. Due to the limited resources many counterparties (both financial and non-financial) have, this will pose a significant operational burden. As an example, the compliance department of a small or medium sized securities dealing firm in Finland may consist of one to two lawyers and a legal secretary.
The explanatory notes suggest that the exemptions were introduced to ease the operational burden and ensure proportionate implementation of margining requirements. However, the requirement of a positive agreement (whether in writing or other equivalent electronic means) in order to benefit from exemptions seems to contradict with such objective. This will create administrative burden even for exempted counterparties, products, and implementation phases.
The benefit of phasing-in is watered down as long as it does not reduce the documentation burden. Therefore we ask ESAs to require counterparties to provide the appropriate documentation only as soon as they become subject to Initial Margin requirements.
Draft rules propose that in case of any other collateral than cash, concentration limits of collateral shall apply. The operation burden of collateral substitution due to concentration limits must be addressed more appropriately. This requirement would result in increased settlement risks and new functionality requirements in collateral management systems. In general it should be noted that in the current market situation, few asset classes move around the proposed diversification limits . Based on this evidence, it is likely that these currently proposed rules would add the operational burden for many participants.
As a solution, the concentration limits should allow for more flexibility. As an example, they should only apply when the limits have been exceeded for a certain amount of days. The level of the limits has to be reconsidered based on the margin surveys. For more comments on this issue, please see our response to Q5.
The current wording of the draft RTS may allow misunderstandings. According to art 2 GEN point 3, counterparties may agree not to exchange IM where the sum of the total IM calculation does not exceed EUR 50 million. Following this requirement we understand that they can also agree to post IM voluntarily in these cases, too.
From an operational perspective it will be simpler to only then run an IM calculation. Additional capital calculations should only be required if the counterparties choose to follow the threshold exemption set in 2.3 GEN.
The regulation of covered bond programs and covered bonds is already quite strict and limiting. They should not be further restricted. Tightening regulation even further, in our opinion, would not benefit the investors or the counterparties hedging their positions. It would do quite the opposite.
The underlying cover pool assets already cover the interest of the hedging counterparties to the same extent as the cover pool assets cover the interest of the covered bond holders. More restrictive regulation would only add administrative burden without notable benefits. A requirement to post collateral in respect of the derivatives which are also covered by the cover pool assets would result in a situation where the hedging counterparties would have a stronger protection than the investors. This would not be consistent with the investor’s protection point of view.
According to the current wording of article 3 GEN 1. (a) no event of default (e.g. payment default) relating to the issuer would be permitted. This requirement would be incompatible with market practice and reach beyond the requirements applied by the rating agencies for AAA compliant covered bond related derivatives. The purpose of this restriction should be to avoid that the derivative is terminated as a result of the issuer’s insolvency, not to prevent the counterparty from terminating upon other limited non-insolvency related defaults.
Hence the requirements in Article 3 GEN 1. (a) should be limited to insolvency related defaults only. We propose ESAs to add the words “insolvency related” before “default” in paragraph (a) of Article 3 GEN.
Regarding Article 3 GEN (1) (F), we believe it should be sufficient to have a de facto 2% over collateralisation and not a necessity to have a legal requirement in each jurisdiction.
No. The current IRB model may be hard to implement in practise as the counterparties may not be able to share sufficient information about the IRB model to be used.
It would be more appropriate that the counterparty which provides for the IRB is required to provide appropriate information for counterparties. This ensures that they are able to fulfil these requirements.
We see that the introduction of concentration limits will largely increase the operational costs. Concentration of collateral will need to be checked and crossing them will trigger collateral substitution calls which in turn need allocated resources. There is an increased risk that the costs of these limits will fall largely on the smaller participants or for example pension funds, which are not able to hold enough cash to fulfil future collateral requirements. Proportionality requirements should hence be introduced.
In general, the list for eligible collateral is well drafted and should be enough to ensure that highly liquid collateral is used. Therefore proportionality does not need to be calibrated to prevent liquidation issues.
Article 7 LEC imposes different concentration limits for both initial and variation margin. These limits are drafted as percentual portions of the whole collateral collected from an individual counterparty. The current concentration scheme poses several problems. First of all, it applies to all counterparties and collateral positions of any size. Secondly, it is likely that the collateral may exceed the threshold one day but with new margin calls, it might be below the threshold already the next day.
Proposing this tight and disproportionate concentration limit structure will only harm many, especially the smaller market participants, without any concrete benefits or an influence on systemic risk. As an example, this could be especially problematic for certain entities (e.g. SPVs) that only hold certain types of assets and thereby are unable to meet these rules. On the other hand, their collateral positions traditionally remain small enough to avoid any pricing or liquidating problems.
The aim of these limits is clear. It is to ensure that the value of collateral and the ability to liquidate the collateral is secured even in the event of a counterparty default. To fulfil this aim in a workable and proportionate way we suggest that concentration limits will be based on appropriately calibrated thresholds. This would mean that only the largest collateral positions are required to be diversified. This is justified on the basis that in large positions concentration on a single product may substantially diminish the value of collateral, as well as the ability to liquidate it in the event of a default.
In addition, we also suggest that highly rated government bonds and covered bonds should be excluded from any concentration limits. This exclusion is needed because the operational costs will out weight the liquidation issues under stressed scenarios. Both of these assets have high level guarantees in either rating or in the collateral. The relative term “high rated” ensures this population of securities is practically fenced from all adverse (negative) credit migration. In other words, the portfolio would only carry jump-to-default risk, which we think could be neglected in this issuer group. Another angle is to say that estimating any credit correlation needed for calculating concentration limits would be a highly theoretical exercise.
As a summary, the structure for concentration limits has to be fine-tuned as follows, to balance the costs and administrative burden and to ensure prevention of systemic risks.
1) Concentration limits should only apply when a value threshold is reached;
2) Limits should only apply when a duration threshold of for example 10 days is exceeded;
3) The level of limits for all assets should be raised from 5 to 10%;
4) A more simple structure with only two or three different concentration limit levels.
In European law-making regulators should always make sure that European companies retain their capability to create growth, and that it is not harmed with more stringent requirements. This is not the case with the current ESA proposal that would ban rehypothecation of collateral. A level playing field between different markets is crucial especially in derivatives markets which are global in nature.
FFI urges ESAs to follow the flexibility provided in global rules and ensure a level playing field for European companies.
Several partially overlapping regulatory initiatives have led to an increased demand of collateral and rehypothecation is an important measure to fulfil these collateral requirements. ESAs need to ensure in their rules that the scarcity of collateral will not prevent new market entries or become too much of a burden for the smaller and medium-sized companies.
The requirements set out in BCBS-IOSCO framework are well suited to ensure high-level protection of the original collateral. Some requirements for rehypothecation of collateral are also provided for in other European regulations (for example Proposal for a regulation of the European parliament and of the Council on reporting and transparency of securities financing transactions (COM (2014) 40 final)). This proposal contains some pretty clearly drafted information requirements that may not fit perfectly for the actual proposal but could suit well for the purpose of risk-mitigation in this respect.
The new requirements regarding the segregation of initial margins and the ban on rehypothecation will require fundamental changes to established collateral management procedures and to the contractual documentation currently in use for margining. These changes will be extremely challenging and time consuming. It is expected that the timeline estimated for the implementation is unrealistic and will be met only with great difficulty. Less formalistic requirements would significantly reduce these time constraints. National regulatory authorities will also have difficulty committing to such a timeline given the potentially large volume of model approvals needed in expectation that the industry moves to a unified modelling approach.