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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?
The requirement to formally opt-out of the requirements on the exchange of margin even where they do not apply would result in a large unnecessary cost in terms of documentation efforts and operational processes. This is due to the significant number of agreements that will have to be negotiated. Smaller counterparties may lose their hedging ability/ be dis-incentivised from adequately hedging their risk. The possibility to rely on “equivalent permanent electronic means” will only be useful to larger counterparties. Pension schemes in particular may find it very difficult to comply with the concentration limits on collateral. They will have to divert investments so that they can satisfy the requirements.

The final draft RTS should ensure that there is no discrimination between EU entities and non-EU entities. The requirement for EU counterparties to collect VM from non-EU corporates - that would be considered non-financial counterparties (NFCs) below the clearing threshold if they were established in the EU - would put EU banks at a competitive disadvantage compared with non-EU banks that are not subject to the same requirements. The lack of a specific reference in Article 11 of EMIR to non-EU entities that would be considered NFCs below the clearing threshold if established in the EU should not prevent the ESAs from treating EU and non-EU corporates equally. The EUR 8 billion IM threshold was not specifically provided for in level 1 either but is nevertheless being proposed in the draft RTS. Article 11 (15)(a) provides the ESAs with a mandate to develop rules on the “levels and types of collateral” that should be exchanged. Therefore our view is that there is no legal impediment to including the further differentiation that is provided in the case of clearing. The final draft RTS should also explicitly specify that all the relevant thresholds are equally available to non-EU entities i.e. the MTA threshold and the EUR 50 million and EUR 8 billion IM thresholds.
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.
We believe that a number of aspects require careful consideration in the final draft RTS:
• To ensure legal certainty, the final draft RTS should clarify that the eligibility and other requirements of the RTS should not apply to margin collected that is not required by the RTS i.e. voluntary collateral , collateral collected in excess of the regulatory requirements or before the RTS requirements apply;

• The operational changes required by the new requirements are significant. CSAs will have to be updated and put in place on an industry wide basis during a compressed implementation window. As previously mentioned we believe that VM requirements should be phased in at a minimum;

• Certain definitions in the draft RTS should also be clarified e.g. the meaning of the “netting set” in the margin period of risk and the definition of an FX forward which at present does not refer to a settlement date and could potentially cover spot transactions;

• Where funds are considered EU FCs under EMIR due to the fact that they are managed by an AIFMD authorised manager, these non-EU funds will be required to collect margin (including IM where the EUR 8 billion threshold is breached). The operational burdens they are faced with could result in an increased cost of doing business for them.
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?
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 use of internal rating models in determining collateral eligibility may have an unintended market impact of releasing non-public information to the market. The internal IRBA approved rating models of banks will be based on a combination of public and non public information, and the use of these models to indicate collateral eligibility may result in the collateral taker releasing non public information to the counterparty, particularly where a request for collateral substitution is required due to a change in CQS. Further, use of internal rating models may lead to disputes if there is disagreement on the collateral quality (particularly if the external CQS differs from the internal CQS).

The explanatory text on page 36 of the consultation paper notes that an institution’s rating model can also be used by the transacting counterparty. Typically an institution is not permitted to share rating information with public side functions therefore we have some concerns around the requirements to share information with third parties. The final draft requirements should clarify how much information is expected to be shared with the counterparty to allow them to fulfil their obligations under the rules. As some rating models are proprietary, only the underlying principles could be disclosed.
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?
We agree that proportionality requirements should be introduced. The current proposals on concentration limits would result in a significant operational burden around the management of collateral. The draft requirements are particularly problematic as regards sovereign debt as in many jurisdictions it is the main form of collateral used. Also, to comply with the proposed limits, pension plans and insurers would potentially need to obtain cash or other securities if they wished to hedge their risks through OTC derivatives. Otherwise, they may not be able to adequately hedge. Further, the concentration limits assume that FCs and NFCs above the clearing thresholds accepting collateral will always be able to identify whether issuers are part of the same "group" within the meaning of EMIR.

To ensure the rules are appropriately calibrated, a QIS could be undertaken and further rules drafted if required. In the meantime national regulators should monitor how counterparties’ practices correspond to the BCBS-IOSCO recommendations around collateral being reasonably diversified.

At a minimum, high quality government bonds should be removed from the requirement while single issuer concentration limits and a cap on all non-government bonds could be put in place (including corporate bonds which are excluded from the concentration limits). Also, to prevent the limits being subject to arbitrage by posting excess collateral, any concentration limit should be expressed as a percentage of a counterparties’ margin requirement under the CSA as opposed to a percentage of the collateral received.
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?
While the BCBS-IOSCO conditions on rehypothecation are unlikely to be achievable in the short term, they could be achievable over time. Were other jurisdictions not to introduce an outright ban in their final rules and a model for rehypothecation is developed which meets the conditions of BCBS-IOSCO, EU banks would be at a clear competitive disadvantage. The final draft RTS should therefore state that rehypothecation is possible where the conditions set out by BCBS-IOSCO are fulfilled. This would ensure that international consistency and emerging rehypothecation models could be kept under review by the ESAs and the BCBS-IOSCO monitoring group.
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Joseph McHale