Draft RTS on risk-mitigation techniques for OTC derivative contracts not cleared by a CCP under Article 11(15) of EMIR
The Regulatory Technical Standards (RTS) are developed by the Joint Committee of the European Supervisory Authorities (ESAs) in order to define the risk mitigation techniques to be put in place for OTC derivatives not cleared by a central counterparty (CCP). In the official table showing the current status of all draft RTS ESMA uses the title “RTS on margin requirements for non-centrally cleared derivatives”.
On 8 March 2016 the European Supervisory Authorities (European Banking Authority, European Insurance and Occupational Pensions Authority, European Securities and Markets Authority) published the final draft Regulatory Technical Standards (RTS) on risk-mitigation techniques for OTC-derivative contracts not cleared by a CCP under Article 11(15) of Regulation (EU) No 648/2012 – EMIR. A feed-back table has also been published.
The RTS cover the risk mitigation techniques related to the exchange of collateral to cover exposures arising from non-centrally cleared over-the-counter (OTC) derivatives. They also specify the criteria concerning intragroup exemptions and the definitions of practical and legal impediments to the prompt transfer of funds between counterparties. These standards aim at increasing the safety of the OTC derivatives markets in the EU.
The draft RTS contain the following provisions:
- For OTC derivatives not clear by a Central Counterparty (CCP), the draft RTS prescribe that counterparties have to exchange both initial and variation margins. This will reduce counterparty credit risk, mitigate any potential systemic risk and ensure alignment with international standards.
- The draft RTS outline the list of eligible collateral for the exchange of margins, the criteria to ensure the collateral is sufficiently diversified and not subject to wrong-way risk, as well as the methods to determine appropriate collateral haircuts.
- The draft RTS lay down the operational procedures related to documentation, legal assessments of the enforceability of the agreements and the timing of the collateral exchange.
- The draft RTS cover the procedures for counterparties and competent authorities related to the treatment of intragroup derivative contracts.
The draft RTS have been developed on the basis of Article 11(15) of Regulation (EU) No 648/2012 (EMIR), which establishes provisions aimed at increasing the safety and transparency of the over-the-counter (OTC) derivatives markets in the EU.
In developing these standards, the ESAs have taken into consideration the need for international consistency and have, therefore, used the framework established by the Basel Committee on Banking Supervision (BCBS) and the International Organisation of Securities Commissions (IOSCO) and the BCBS supervisory guidance for managing risks associated with the settlement of foreign exchange transactions, while taking into account the specific features of the European financial market.
The deadline for adoption by the Commission was 8 June 2016.
On 9 June 2016, the European Commission notified the ESAs of a delay in the endorsement process. On 28 July 2016 the letter regarding the Commission’s intention to endorse with amendments the draft RTS was published. According to the letter the Commission is intending to make a number of clarifications and restructure the legal text in line with applicable principles of legislative drafting. This includes the correction of a number of apparent oversights and omissions that have been identified through staff discussions. The most important ones relate to:
- The introduction of a recital containing the reasoning for a delayed phase-in of the requirements for equity option;
- The clarification on the fact that Union counterparties wishing to obtain an intragroup exemption from the requirements may submit the relevant application after the entry into force of the RTS;
- The clarification that cash initial margin may be held, in additional to credit institutions authorized in accordance with the Capital Requirement Directive, with equivalent third country institutions;
- The clarification on the fact that requirements concerning FX derivative contract should start to apply from the date of application of the relevant Delegated Act under the Markets in Financial Instruments Directive II framework, as opposed to the date of entry into force of this Regulation.
According to the Commission it is necessary to amend one particular provision concerning the concentration limits for pension scheme arrangements. This amendment is based on new evidence and should be taken into consideration in order to ensure the proportionate application of those requirements. Given the fact that the application of such concentration limits to certain pension scheme arrangements would require them to enter into foreign currency transactions introducing the costs and risks of foreign currency mismatches, it would be disproportionate to apply the concentration limits in the same manner as other counterparties. Therefore the Commission intends to remove the limits for pension scheme arrangements, in order to prevent such costs and risks, in line with the co-legislators intention to avoid excessive burden on the retirement income of future pensioners as reflected in Rectail 26 of EMIR. The Commission considers that it is more appropriate to replace the concentration limits by specific management risk tools to monitor and address potential risks.
As communicated to the European Parliament and Council and the ESAs on 8 June 2016, the Commission believes that the implementation dates proposed by the ESAs, although they are in line with international principles, they are not viable given the timeframe available to the Commission to complete its adoption procedure and for the European Parliament and Council to conduct scrutiny. The Commission is proposing an adjusted timeline for implementation of the requirements.
The Commission intends to amend the draft RTS in a way that is explained above and detail in the Annex to the letter. The ESAs may amend the draft RTS within 6 weeks on the basis of the Commission’s proposed amendments and resubmit it in the form of a formal opinion to the Commission.
On 9 Sept ESAs published their Opinion (dated 8 Sept 2016) addressed to the European Commission expressing disagreement with its proposed amendments to the final draft Regulatory Technical Standards (RTS) on risk mitigation techniques for OTC derivatives not cleared by a central counterparty, which were originally submitted for endorsement on 8 March 2016.
Following the European Commission’s communication on 28 July 2016, of its intention to endorse the ESAs’ final draft RTS with amendments, the ESAs issued an Opinion rejecting some of the proposed changes.
In particular, the ESAs disagree with the European Commission’s proposal to remove concentration limits on initial margins for pension schemes and emphasise that these are crucial for mitigating potential risks pension funds and their counterparties might be exposed to.
In addition, in the Opinion the ESAs observed the following:
- As with other thresholds in the RTS submitted to the European Commission, the calculation of the threshold against non-netting jurisdictions should consider both legacy and new contracts.
- With reference to covered bonds, the additional condition included in the European Commission’s proposed amendments would have the effect of ranking derivatives counterparties after bond holders, which is contrary to the reasoning established in European Market Infrastructure Regulation (EMIR) to grant a preferred treatment to cover bonds.
- The ESAs recommend providing clarity that non-centrally cleared derivatives concluded by central counterparties (CCPs) are not covered by this regulation. This has been a source of concern for stakeholders.
- More clarity should also be brought to the application of the RTS to transactions concluded with third country counterparties, in particular non-financial counterparties.
- The delayed application to intragroup transactions should be maintained to allow national competent authorities to complete the relevant approval process before the obligation will start applying.
The ESAs believe that the introduction of a number of wording changes proposed by the European Commission may lead to a different application of the provisions compared to their original text of the RTS and, therefore, advise amending them accordingly.
A version of the draft RTS containing all the aforementioned corrections in detail is included as an Annex to the Opinion.
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