- Question ID
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2024_7028
- Legal act
- Regulation (EU) No 575/2013 (CRR)
- Topic
- Credit risk
- Article
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111
- COM Delegated or Implementing Acts/RTS/ITS/GLs/Recommendations
- Not applicable
- Article/Paragraph
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n.a.
- Name of institution / submitter
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Eurex Clearing AG
- Country of incorporation / residence
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Germany
- Type of submitter
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Credit institution
- Subject matter
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Non-applicability of the CRR (Capital Requirements Regulation) regarding OCCPs
- Question
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According to Article 111 CRR, OCCPs must be included in the calculation of the Total Capital Ratio (TCR) under Pillar I, even though their economic risk is fully mitigated by the DvP mechanism. Eurex Clearing AG only includes OCCPs in their balance sheet, as per accounting standards. While the risk of OCCPs is covered in the CCP risk management framework through margins and other lines of defense, they cannot be mitigated through collateralization or netting under the CRR framework.
Regarding the information in section 1 and 2, ECAG would like to inquire whether the OCCPs can be exempted from the application of Article 111 CRR.
- Background on the question
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ECAG (Eurex Clearing AG) is an EMIR (European Market Infrastructure Regulation) authorized CCP and must fulfil regulatory capital requirements as prescribed in Article 16 EMIR and, due to its banking licence, also according to Article 92 Capital Requirements Regulation. Consequently, it needs to calculate the Total Capital Ratio (TCR) under Pillar I as the ratio between its own funds and the risk weighted assets. Besides the components capturing operational and market risk, a dedicated credit risk component is considered. In principle, according to Article 111 CRR, all balance sheet items are considered. This credit risk component comprises, inter alia, nostro, intercompany and treasury reverse repo transactions, so-called Open CCP transactions.
It is standard practice of CCPs to pre-finance the first, purchase-leg of cleared FWB (Frankfurter Wertpapierbörse) Transactions, Eurex Repo Transactions and Eurex Transactions with physical delivery obligations before the second, sell-leg is initiated. The financial risk of the two settlements legs related to such transactions is insignificant as the settlement of securities always follows the delivery vs. payment principle (DvP). I.e., at any point in time until the settlement of each leg is final, the countervalue of the securities offsets the cash claim or vice versa, hence, economically, Eurex Clearing is never exposed to the notional value of the transaction.
The two legs are instructed and processed on the same business day (i.e., on the contractual settlement day). However, in rare cases, it might happen that Eurex Clearing has already settled the first (sell) leg on the contractual settlement day but is not able to onwards deliver the securities to the original purchaser on the same day. This special constellation constitutes the so-called Open CCP transactions (hereafter “OCCPs”).
In accordance with the accounting standards under the German Commercial Code (Handelsgesetzbuch), only these OCCPs are shown on Eurex Clearing AG’s balance sheet and, thus, are considered in TCR calculations.
Eurex Clearing employs certain punitive measures such as penalties for late/failed settlements to maintain a high settlement discipline of its Clearing Members and hence to minimize OCCPs. This, however, does not prevent OCCPs due to technical circumstances. These can be more frequently observed in specific market situations, e.g., after the expiry date of large derivative transactions due to the resulting higher settlement volumes.
Under the CRR framework, risk positions arising from OCCPs cannot be mitigated by consideration of collateralization, netting or any other way, even though the economic risk from OCCPs is fully mitigated by the DvP-Mechanism (see explanation above).
Residual risks from potential changes in securities values are covered in the standard CCP risk management framework via margins, namely by the current liquidating margin (“CLM” -backwards looking component, i.e., mark-to-market), the initial margin (“IM” - forward looking component), as well as the other lines of defense (e.g., Default Fund). As a result, the real economic risk from OCCPs is covered by CCP collateralization mechanism, which contrasts consideration of their full nominal countervalue for determining the credit risk component under CRR.
The methodology to determine capital requirements under Article 16 EMIR considers two elements of credit risk:
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requirements for credit, counterparty and market risks calculated based on CRR methodology, and
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a reduction of available capital by the dedicated amount attributed to the default fund.
Currently, OCCPs are considered under both risk frameworks leading to a double consideration:
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Under the standard approach of the CRR framework, OCCPs are considered in the credit risk component of the risk-weighted exposure amounts (RWA) calculation methodology as defined in Article 113 CRR.
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While determining RWAs, OCCPs are considered with their full notional amount, subject to the applicable counterparty risk weights, but without the possibility to apply any risk mitigation techniques.
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Under EMIR, OCCPs are included in the general CCP risk management framework and, thus, their present value and potential future exposure is collateralized by margins (Total Margin Requirement). Beyond this, any residual tail risks, estimated by means of stress testing, are further covered by the Default Fund, including the dedicated amount of Eurex Clearing which yet reduces the available capital.
Given that OCCPs relate to the core activities of clearing and are covered by the dedicated amount, Eurex Clearing holds the view that capital requirements for these positions, like for any other cleared positions, are already covered by the provisions for handling the dedicated amount (Article 16 (1) EMIR). This provision states that the dedicated amount is to be deducted from the available capital and that only the remainder can be used to cover other credit risks from “banking” activities, market risk and operational risks.
A consideration of OCCPs in the credit risk component prescribed by the CCR framework which is the basis for the EMIR capital requirements calculations, thus, leads to an economically, unjustified double consideration of such positions in ECAG’s total capital ratio.
Whereas Section 2 para. 9a and 9b of the German Banking Act (Kreditwesengesetz – “KWG”) foresees an express differentiation between the regulatory oversight on the
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provision of banking services, which shall be governed by the KWG and the CRR, and
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the provision of CCP services, falling under the scope of EMIR,
Eurex Clearing AG understands that the CRR does not provide for a corresponding distinction.
However, despite the lack of an express provision, Eurex Clearing AG holds the view that the need for a strict differentiation clearly follows from other provisions under European law.
(a) Separate legal regimes for credit institutions and CCPs
The legal separation between credit institutions and CCPs particularly results from the fact that the European legislator has enacted two separate regulatory regimes for credit institutions as well as CCPs.
In this context, both regimes clearly distinguish themselves from each other in terms of their areas of application:
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The CRR as well as the CRD (Capital Requirements Directive) IV clearly apply only to "institutions".
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Pursuant to Article 1 CRR, the CRR establishes uniform rules for institutions within the scope of the CRR.
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The scope of CRD IV is also limited to "institutions" in Article 2 (1) CRD IV.
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According to Article 4 (1) No. 3 CRR, the term “institution” also includes “credit institutions”.
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And the term 'credit institution' refers to an “undertaking the business of which is to take deposits or other repayable funds from the public and to grant credits for its own account.”
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Whereas EMIR explicitly refers only to "CCPs".
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Pursuant to Art 2 (1) EMIR, “CCP” means “a legal person that interposes itself between the counterparties to the contracts traded on one or more financial markets, becoming the buyer to every seller and the seller to every buyer.”
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Due to the clearly distinguishable scopes of application, it can be concluded that credit institutions and CCPs are considered as two completely different categories of service providers that are subject to separate regulatory regimes.
(b) With respect to the treatment of OCCPs, EMIR is more suitable than the banking regime
Both regulatory regimes, the regime for credit institutions and the CCP regime, foresee independent requirements which are tailored to the specific risk profile of the respective activities.
Both regimes foresee their own requirements regarding:
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own funds requirements, and
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recovery and resolution.
With respect to OCCPs, EMIR constitutes the more suitable regime to cover the specific risks of cleared OCCPs.
Under EMIR, “clearing” is defined as “the process of establishing positions, including the calculation of net obligations, and ensuring that financial instruments, cash, or both, are available to secure the exposures arising from those positions.”
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Based on this definition, OCCPs are cleared FWB Transactions and Eurex Repo Transactions and Eurex Transactions with physical delivery obligations, which remain in the systems of Eurex Clearing AG as pending transactions because the buyer of the securities is not able to pay the purchase price at the agreed purchase time.
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Additionally, OCCPs are fully covered by the Clearing Member’s Margin Requirement (Art 41 EMIR) and are also protected by the Default Fund Contribution (including the Dedicated Amount – Art 42, 43 EMIR), which Eurex Clearing AG collects from its Clearing Members. If OCCPs are pending, OCCPs are fully collateralized via the mark-to-market margin (Current Liquidating Margin) and the forward-looking margin (Initial Margin).
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Finally, in case of the occurrence of a default scenario with respect to the Clearing Member holding OCCPs, OCCPs will be included in the overall close-out netting mechanism (so-called Difference Claim).
As a result, OCCPs clearly relate to the core activities of clearing and have no connection to taking deposits or granting credits, so that a treatment of OCCPs in accordance with the credit institution regime would appear unnatural.
(c) Clear differentiation between capital requirements under the CRR and EMIR under RTS 152/2013
Further, also Regulation (EU) No 152/2013 regarding regulatory technical standards on capital requirements for central counterparties (“RTS 152/2013”) expressly differentiates between the capital requirements for banking business governed by the CRR and the capital requirements for CCP services regulated by EMIR and RTS 152/2013.
In particular, Recital (5) of RTS 152/2013 states the following:
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“Directive 2006/48/EC and Directive 2006/49/EC of the European Parliament and of the Council of 14 June 2006 on the capital adequacy of investment firms and credit institutions (5) are an appropriate benchmark for the purpose of establishing capital requirements to cover credit, counterparty and market risks non covered by specific financial resources, since they are similar to those carried out by credit institutions or investment firms.”
Thus, the European Commission realized that the capital requirements to be enacted for CCPs had to be similar, but different to the capital requirements applicable to credit institutions. Instead of a simple reference to the provisions under the CRR, the European Commission decided to implement individual provisions regulating the capital requirements for CCPs under RTS 152/2013.
(d) Express statements in EMIR and RTS 152/2013 that no additional capital requirements should apply to exposures already covered by Margin and Default Fund Contribution
Art 16 EMIR and RTS 152/2013 regulate the capital requirements for CCPs conclusively. The application of additional capital requirements arising from the CRR to CCP services would undermine this capital requirements regime for CCPs.
Article 16 (2) Sentence 2 of EMIR states the following:
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“It (CCP’s capital) shall at all times be sufficient to ensure…an adequate protection of the CCP against credit, counterparty, market, operational, legal and business risks which are not already covered by specific financial resources as referred to in Articles 41 to 44.”
Similar statements can be found under Art 4 of RTS 152/2013:
“Article 4 - Capital requirements for credit risk, counterparty credit
risk and market risk which are not already covered by specific financial resources as referred to in Articles 41 to 44 of Regulation (EU) No 648/2012
[…]
2. For the calculation of capital requirements for market risk which is not already covered by specific financial resources as referred to in Articles 41 to 44 of Regulation (EU) No 648/2012, a CCP shall use the methods provided for in Annexes I to IV to Directive 2006/49/EC.
3. For the calculation of the risk-weighted exposure amounts for credit risk which is not already covered by specific financial resources as referred to in Articles 41 to 44 of Regulation (EU) No 648/2012, a CCP shall apply the Standardised Approach for credit risk provided for in Articles 78 to 83 of Directive 2006/48/EC.
4. For the calculation of the risk-weighted exposure amounts for counterparty credit risk which is not already covered by specific financial resources as referred to in Articles 41 to 44 of Regulation (EU) No 648/2012, a CCP shall use the mark-to-market Method provided for in Annex III, part 3 to Directive 2006/48/EC and the Financial Collateral Comprehensive Method applying supervisory volatility adjustments provided for in Annex VIII, Part 3 to Directive 2006/48/EC.”
The wording of both provisions clearly shows that the CCP capital requirements regime only applies to the extent that the risk arising from cleared transactions is not already covered by the Initial Margin and Default Fund Contribution the CCP collects from its Clearing Members.
By way of comparison, the restriction to exposures which are not already covered by the Initial Margin and the Default Fund Contribution corresponds to the credit risk mitigation measures under the CRR with respect to collateral pursuant to Articles 197 to 199 and 207 CRR. Exposures which are already sufficiently covered by collateral do not give rise to further risks that would need to be covered by additional regulatory capital. This rationale is clearly expressed in Article 4 of RTS 152/2013.
(e) EBA and ESMA Report on the joint functioning of the CRR with EMIR
On 17 January 2017, the European Banking Authority (EBA) and the European Securities and Markets Authority (ESMA) published a report about their main conclusions from the analysis of the joint functioning of the CRR with EMIR with respect to CCPs, which simultaneously qualify as credit institutions (“Report”).[1]
EBA and ESMA concluded that the full application of the CRR to CCPs that are also holding a banking licence can generate duplicative capital requirements with respect to exposures, which have already been covered by specific financial resources in accordance with Articles 41 to 44 EMIR.
Under item 17. of the Report, EBA and ESMA stated the following:
“Accordingly, it is clear that, for any CCP acting under the EMIR with a banking licence, there should not be additional capital requirements under the CRR for risks stemming from normal CCP activities, as these are already covered by specific financial resources, as referred to in Articles 41 to 44 of the EMIR and the EBA technical standard on capital requirements.”
Under item 89. of the Report, EBA and ESMA concluded the following:
“Therefore, the EBA and ESMA invite the Commission to clarify that CCPs holding a banking licence should be exempted from specific points as follows:
Points a) to d) and point f) of Article 92(3) of the CRR should not be applicable to the credit risk, CCR and market risk for exposures that are already covered by specific financial resources as referred to in Articles 41 to 44 of the EMIR.”
[1]https://www.esma.europa.eu/sites/default/files/library/esas-2017-82_report_on_the_interaction_with_emir.pdf
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- Submission date
- Rejected publishing date
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- Rationale for rejection
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- Status
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Rejected question