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Question 1. What costs will the proposed collateral requirements create for small or medium-sized entities, particular types of counterparties and particular jurisdictions? Is it possible to quantify these costs? How could the costs be reduced without compromising the objective of sound risk management and keeping the proposal aligned with international standards?
EMIR Article 11(15) mandates ESAs to develop standards including the levels and type of collateral….for compliance with paragraph 3; and paragraph 3 refers to “non-financial counterparties referred to in Article 10…after the clearing threshold is exceeded.”.

Jurisdictions: The current RTS draft requires EU FC and EU NFC+ entities to hold initial and variation margins from non-EU entities that would be classified as non-financial entities below the clearing threshold if they were established in the EU (non-EU NFC-). However, EU FC and EU NFC+ entities are not required to request collateral from non-financial entities below the clearing threshold and established in the EU (EU NFC-).

Counterpart Types: Including a requirement for EU FC and EU non-NFC+ entities to margin non-EU NFC- entities, extends the scope of margining to NFCs that are not referred to in Article 10. This represents an increase in EMIR scope, beyond the level 1 text and is inconsistent with ESA’s mandate to develop standards that keep in mind the need for international consistency, including BCBS-IOSCO Key Principle 2, Requirement 2 paragraph 2.4 which advocates only inclusion of “financial firms and systemically important non-financial firms”.

Costs: For non-EU NFC-, under current draft proposals, cost would be driven by the new requirement to post initial margin. For a typical small to medium-sized entity, that was non-EU but would otherwise qualify as NFC-, initial margin on treasury hedging activity would be the primary contributor if such organisations continue to trade with EU FC or EU NFC+ entities. For NFC- entities established outside of the EU, avoiding this cost creates an incentive to increase exposure to EU NFC- entities and to reduce exposure to EU FC and EU NFC+ entities which would undermine the aim of EMIR to increase the safety of OTC derivative markets.

Cost Quantification: Whilst it is difficult to derive an exact cost, small to medium non-EU entities would have limited access to capital markets and would therefore be restricted to posting cash which has been withheld from capital investment or generated through borrowing. Whilst it is market practice to require variation margin, the OTC interest rate swap market (similar to the OTC FX market) does not currently require initial margin. An annual cost in the order of EUR10million per entity, is implied by using our own operating model as a starting point, applying an appropriate cost of debt and scaling to the requested entity size. Although initial margins for treasury financing hedges would comprise the majority of that cost, initial margins and variation margin for commodity hedges would also contribute to the overall cost for commodity producers. Increasing the scope of EMIR margining requirements to include non-EU NFC- entities, without recognising that their need to hedge is no different to EU NFC- entities, would undermine the aim of paragraph 35 of EU regulation 648/2012 to “ensure a level playing field in financial markets”.

We would recommend that non-EU entities that would qualify as NFC-, if they had been established within the EU, should not be included within the scope of the margining obligation on EU FC and EU NFC+ entities. This recommendation is within the constraints of the level 1 text, would be consistent with BCBS-IOSCO Key Principle 2, Requirement 2 and would be aligned to the existing common treatment of both EU NFC- and non-EU NFC- entities under the EMIR clearing and other risk mitigation requirements.
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.
The current RTS draft requires EU FC and EU NFC+ entities to hold initial and variation margins from non-EU entities that would be classified as non-financial entities below the clearing threshold if they were established in the EU (non-EU NFC-). However, EU FC and EU NFC+ entities are not required to request collateral from non-financial entities below the clearing threshold and established in the EU (EU NFC-). If this proposal remains, it will create a new category of counterparty to further complicate the management of credit exposures.

Including a requirement for EU FC and EU non-NFC+ entities to margin non-EU NFC- entities, extends the scope of margining to NFCs that are not referred to in Article 10. This represents an increase in EMIR scope, beyond the level 1 text and is inconsistent with ESA’s mandate to develop standards that keep in mind the need for international consistency, including BCBS-IOSCO Key Principle 2, Requirement 2 paragraph 2.4 which advocates only inclusion of “financial firms and systemically important non-financial firms”.

Operationally, NFC- entities, whether established within the EU or otherwise, are outside the scope of the EMIR clearing obligation if they do not exceed the clearing threshold. Without the requirement to clear, it is unlikely that such entities would have the infrastructure or systems to support bi-lateral margining. It would therefore seem better aligned to EMIR paragraph (14) “creating a level playing field between market participants” if NFC- entities, whether established within the EU or otherwise, are both treated equally in determining the scope of margining for OTC derivatives that are not cleared.

We would recommend that non-EU entities that would qualify as NFC-, if they had been established within the EU, should not be included within the scope of the margining obligation on EU FC and EU NFC+ entities. This recommendation is within the constraints of the level 1 text, would be consistent with BCBS-IOSCO Key Principle 2, Requirement 2 and would be aligned to the common treatment of both EU NFC- and non-EU NFC- entities under the EMIR clearing and other risk mitigation requirements.
Question 3. Does the proposal adequately address the risks and concerns of counterparties to derivatives in cover pools or should the requirements be further tightened? Are the requirements, such as the use of the CRR instead of a UCITS definition of covered bonds, necessary ones to address the risks adequately? Is the market-based solution as outlined in the cost-benefit analysis section, e.g. where a third party would post the collateral on behalf of the covered bond issuer/cover pool, an adequate and feasible alternative for covered bonds which do not meet the conditions mentioned in the proposed technical standards?
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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?
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Question 5. How would the introduction of concentration limits impact the management of collateral (please provide if possible quantitative information)? Are there arguments for exempting specific securities from concentration limits and how could negative effects be mitigated? What are the pros and cons of exempting securities issued by the governments or central banks of the same jurisdiction? Should proportionality requirements be introduced, if yes, how should these be calibrated to prevent liquidation issues under stressed market conditions?
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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?
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Contact name
Vince McCallion