Response to joint Consultation on draft RTS on risk-mitigation techniques for OTC-derivative contracts not cleared by a CCP
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Agreements between counterparties will also have to be expanded to include all new arrangements required by this new framework. The amount of work market participants will have to develop to update contracts with their counterparties is unnecessarily increased, as all the exemptions included in the proposed RTS will have to be agreed in writing in their bilateral arrangements.
The cost of implementing the new minimum margin standards would be less burdensome if the exemptions were directly applicable, having the counterparties only to reflect in their arrangements the cases in which they agree not to make use of them.
Moreover, the use of models in bilateral agreements requires the agreement of both counterparties on very specific details of the models to be used for each type of derivative. As small differences of parameters or data may lead to material discrepancies in the outcome of the model, a large number of disputes may arise between counterparties.
The RTS does not contemplate approval of the initial margin model by EU competent authorities (as called for by paragraph 3.3 of the BCBS-IOSCO framework document). This introduces a regulatory uncertainty for counterparties relying on the initial margin model, exposing them to a liquidity risk if their competent authority deems the model not to be appropriate subsequent to its adoption.
The new requirements regarding the segregation of initial margins and the ban on re-use/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 consumingThe timeline foreseen for the implementation is unrealistic and will only be met with great difficulty (not just by industry, but also by national authorities, given the potentially large volume of model approvals needed, either to approve adjustments to existing models or in view of the need to approve a unified modelling approach which is expected to be developed).
A phase-in period with possibly less formalistic requirements would significantly help reduce these time constraints.
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.
In addition to the effects on market liquidity, the new margin requirements demand a strengthening of the operational processes that will be costly both on the implementation period and on an on-going basis. Entities will have to develop more sophisticated processes to calculate margins, control the quality of collateral posted and collected, increase protection on collateral collected and be ready to access and manage collateral when counterparties default.Agreements between counterparties will also have to be expanded to include all new arrangements required by this new framework. The amount of work market participants will have to develop to update contracts with their counterparties is unnecessarily increased, as all the exemptions included in the proposed RTS will have to be agreed in writing in their bilateral arrangements.
The cost of implementing the new minimum margin standards would be less burdensome if the exemptions were directly applicable, having the counterparties only to reflect in their arrangements the cases in which they agree not to make use of them.
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?
The rates for the standardized tables on the calculation of initial margin and haircuts on collateral proposed by the RTS (same rates as proposed by the BCBS-IOSCO framework) are disproportionally high with respect to the expected outcome of the application of quantitative models (see results of the BCBS-IOSOC QIS). This provides a great advantage to the users of quantitative models. However, these models are difficult to design and handle, which in turn gives a competitive advantage to the larger and more sophisticated market players, which may lead to a concentration of the OTC derivatives market into a small number of large players.Moreover, the use of models in bilateral agreements requires the agreement of both counterparties on very specific details of the models to be used for each type of derivative. As small differences of parameters or data may lead to material discrepancies in the outcome of the model, a large number of disputes may arise between counterparties.
The RTS does not contemplate approval of the initial margin model by EU competent authorities (as called for by paragraph 3.3 of the BCBS-IOSCO framework document). This introduces a regulatory uncertainty for counterparties relying on the initial margin model, exposing them to a liquidity risk if their competent authority deems the model not to be appropriate subsequent to its adoption.
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?
It is important to note that the concept of rehypothecation is also currently used in the context of the European Commission’s proposal for a Securities Financing Transactions Regulation, in the discussion about implementing measures for MiFID2 in ESMA and, at global level, in the context of the 2013 FSB policy recommendations on securities lending and repos. In this respect, it is crucial to ensure consistency and coordination between these parallel political and legislative developments. Rehypothecation generally plays an important role in providing liquidity to markets, which is already under pressure from other regulations such as the LCR and initial margining requirements. Understanding and monitoring the interactions of these rules as they enter into force will remain important for the supervisory community.The new requirements regarding the segregation of initial margins and the ban on re-use/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 consumingThe timeline foreseen for the implementation is unrealistic and will only be met with great difficulty (not just by industry, but also by national authorities, given the potentially large volume of model approvals needed, either to approve adjustments to existing models or in view of the need to approve a unified modelling approach which is expected to be developed).
A phase-in period with possibly less formalistic requirements would significantly help reduce these time constraints.
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