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European Association of CCP Clearing Houses (EACH)

Respondents are invited to comment on the proposal in this section concerning the timing of calculation, call and delivery of initial and variation margins.
Introduction

EACH considers that specific attention should be given to commensurate margins, international consistency and regulatory certainty.
EACH strongly believes that:
• The overall capital and funding associated with central clearing should never exceed the costs of holding the same contracts in a non-centrally cleared environment.
• A harmonized approach between regulators is key to avoid regulatory arbitrage and bifurcation of the global liquidity pool.
• The final rules should be communicated early in order to allow participants adequate time for implementation in advance of September 2016.

EACH strongly supports EMIR’s central objective of managing systemic and contagion risk by promoting CCP Clearing of standardised OTC Derivatives.

EACH fully supports the international regulatory drive to make the OTC derivatives markets safer and more efficient and to remove incentives for participants not to clear derivatives where an authorised CCP is available to clear that class of instrument. The benefits of CCP clearing (and the discipline of full initial and variation margining) have long been recognised in a range of asset classes. EACH members provide clearing of OTC derivatives in commodities, credit default swaps, equities, foreign exchange and interest rate and are working to extend their product offering. While we recognise that bespoke tailored derivatives that are transacted between counterparties in order to hedge specific business risks may not be suitable for CCP clearing, incentives to encourage the clearing of OTC derivatives, where possible, in all asset classes, should be established in European legislation.



In this context EACH believes that the requirements proposed by the ESAs do not adequately reflect the risk profile of non-CCP cleared transactions. In addition, those requirements seem to be weaker than the ones for CCP cleared transactions, which in our opinion puts into question one of the main goals of EMIR: ensuring a safer and more efficient OTC derivatives market.

In particular:

• Article 2 MRM (Confidence interval and risk horizon) – EACH believes that the 99% confidence level is less than the minimum required for OTC centrally cleared contracts, which under EMIR is set at a CI of 99.5%.
• Article 1 SMI (Standardised method) and Annex IV:
In our opinion, 5+ category should be more granular, as 4% may not correspond well (being too little) with the risk of derivatives with maturities longer than 5Y (e.g. 20Y) as their risk may be higher in case of trades based on specific reference rates. Thus this would make margining of non-centrally cleared OTC trades less conservative than that applied by CCPs, which should not be the case. This is also a disincentive towards central clearing of such trades in the future.
• Article 1 EIM (Initial margins)
EACH believes that the requirements for the calculation of initial margins should be aligned with the ones of the BCBS/IOSCO’s margin requirements for non-centrally cleared derivatives.
Respondent are invited to provide comments on whether the draft RTS might produce unintended consequence concerning the design or the implementation of initial margin models.
EACH believes that the margin framework for non-cleared derivatives should support the G20 commitment that “Non-centrally cleared derivatives contracts should be subject to higher capital requirements” and the BIS aim that these margin rules should promote central clearing.
CCP margin models are subject to strict quantitative and qualitative regulatory requirements, and are extensively tested and validated.

EACH considers that CCP regulatory margin requirements should be considered the minimum standard required for the mitigation of systemic risk and should form the base for the models applied to non-centrally cleared derivatives.

Concrete proposals
• Article 1 GEN (General counterparties’ risk management procedures) - EACH supports the prompt exchange of VM and IM and believe that one day should be enough. If mark-to-market is daily, then collateralisation must be possible too. If cut-off times for currencies are the difficulty, then more IM is necessary as the starting point is off given late VM payments. The current requirements in the proposed RTS with regard to the frequencies of IM calculation (up to once in 10 days) and timelines for collection (within a business day) are much weaker than that for CCP IM (~intraday and within an ~hour). This creates a disincentive for CCP clearing of OTC derivatives.

EACH however believes that with regard to the netting and portfolio effect, which represent the biggest driver for margin size, the requirements for non-cleared derivatives are weaker than for cleared OTC derivatives. As an example, the proposed RTS do not include any potential restriction of offsets while this is the case for CCP-cleared derivatives in the relevant EMIR RTS.

• Article 4 GEN (Minimum Transfer Amount) – EACH acknowledges that the minimum transfer amount is allowed under the international standards, however EACH believes that the provisions for a minimum transfer amount go against the goal set by the G20 of prudent risk management for OTC derivatives. They effectively mean that there is constantly an open risk exposure. These provisions also create a disincentive to CCP clearing, where no minimum transfers are allowed.
• Article 8 GEN (Treatment of derivatives associated to covered bonds for hedging purposes) – EACH members do not understand the logic behind the exemption for derivatives associated to covered bonds for hedging purposes.
• Article 2 MRM (Confidence interval and risk horizon) - The use of a 99% CI over MPOR of 10 days is different from current CCP margin requirements. A 3-5 year calibration period may lead to disregard key periods of historical volatility, which are captured by CCPs. In addition, IM is computed one day after portfolio changes, which means that the MPOR is not really 10 days.
• Article 4(2) MRM (Diversification, hedging and risk offsets across underlying classes) - EACH generally agrees with the list of underlying asset classes included in Article 4(2) MRM. However, regulators should encourage that higher initial margin is required for more complex trades.
• Article 1 LEC (Eligible collateral for initial and variation margin) - In the opinion of EACH members the list of permissible collateral pool for non-centrally cleared derivatives included in Article 1 LEC is substantially broader than that permitted to CCPs (e.g. no restrictions on UCITS funds, corporate bonds, senior tranches, convertibles, etc.). Additionally, EACH believes that this broad group must be coupled with diversification requirements, otherwise it is simply a lower standard, not a way to address diversification.

In addition, the proposal to allow ‘grace period’ after a member downgrade is not something that is allowed under the EMIR RTS for CCP-cleared derivatives. This therefore represents an additional disincentive towards CCP-clearing.

• Article 6 MRM (Qualitative requirements) - Validation requirements are in our opinion weaker in scope and frequency than those for CCP-cleared OTC derivatives.
Respondents are invited to comment on the requirements of this section concerning treatment of FX mismatch between collateral and OTC derivatives.
EACH wishes to underline the fact that the recognition of FX risk is a critical factor in assessing the adequacy of margins. The absence of FX haircuts for VM or IM may allow for hidden risk within the market.
Contact name
Rafael Plata