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Summary of Regulatory Technical Standards on Risk-Mitigation Techniques for OTC Derivative Contracts Not Cleared by a CCP

Core Content

This document outlines the Regulatory Technical Standards (RTS) under Article 11(15) of Regulation (EU) No 648/2012 (EMIR), focusing on risk-mitigation techniques for OTC derivative contracts not cleared by a Central Counterparty (CCP). It includes feedback received during two consultation processes and the final amendments to the RTS, covering key aspects such as collateralisation, netting agreements, initial and variation margin, collateral eligibility, and special cases.

Main Views and Key Information

1. Definitions

• Termination and Insolvency: The RTS should apply to both events of default and other contractual termination events. The ESAs agreed to include both types of events in the final version.

• Definition of 'Group':

  • Respondents expressed concerns about defining 'group' in a way that is not aligned with market practices.
  • The definition of 'group' is already set out in EMIR, and introducing a different one would be inconsistent.
  • A dedicated paragraph was added to address the treatment of a group of funds.

• Definition of 'Counterparty':

  • The term 'counterparty' should be defined to avoid confusion, especially with third-country entities.
  • The RTS adopt the approach of requiring "collecting only" (not mandating an exchange of margins).
  • Financial and non-financial counterparties (NFCs) established in the EU are subject to the requirements.
  • The definition remains as proposed in the Consultation Paper.

2. Voluntary Collateralisation

• There should be a distinction between margin required under the RTS and additional margin collected voluntarily.
• The RTS do not apply to voluntary collateral.
• A recital was added to clarify that collateral exchanged in excess of what is required by the regulation is not subject to the RTS.

3. Scope of Coverage – Instruments Subject to the Requirements

• Grandfathering: The rules apply to new contracts from 1 December 2015 for variation margin (VM), and from phase-in dates for initial margin (IM). There is no retrospective application.
• Scope of Instruments in Different Jurisdictions:
  • The scope of instruments covered by the RTS should be consistent with international standards.
  • The introduction of margin requirements for single stock options and index options was postponed to avoid regulatory arbitrage.
  • Instruments such as equity options and derivatives on equity indices are not subject to special treatment.

4. Scope of Coverage – Counterparties

• UCITS and Other Investment Funds:

  • There was a suggestion to clarify the treatment of investment funds as part of a group.
  • The BCBS-IOSCO framework addresses the treatment of these situations, and the RTS should align with it.
  • A dedicated paragraph was added to address the treatment of a group of funds.

• Institutions for Occupational Retirement Provision (IORPs):

  • The RTS should consider the specificities of IORPs.
  • The treatment of IORPs was included in the final RTS.

• Sovereigns, Central Banks, and Multilateral Development Banks:

  • These entities are subject to the RTS unless they are exempt under other regulations.

• EU, EEA, and Third-Country NFCs:

  • The RTS apply to EU and EEA NFCs exceeding the clearing threshold (NFC+).
  • Third-country NFCs are not included unless they are systemically important.

• Microfinance, Real Estate, and Other Specialised Funds:

  • These entities are subject to the RTS unless they are exempt under other regulations.

5. Documentation and Legal Basis

• The documentation requirements for agreements and the operational process for the exchange of collateral were discussed.
• The legal basis for these requirements was clarified.

6. EUR 8 bn Notional Threshold – Calculation and Implementation

• The EUR 8 billion notional threshold applies to initial margin (IM) requirements.
• The phase-in period for IM is designed to allow for a smooth transition.

7. EUR 50 m Threshold

• The EUR 50 million threshold applies to variation margin (VM) requirements.

8. Margin and Collateral Agreements (MTA)

• The MTA is a key tool for managing margin and collateral requirements.
• The legal review of MTA is important to ensure compliance with international standards.

9. Special Cases

• Covered Bonds: Derivatives associated with covered bonds should be treated consistently with other instruments.
• Intragroup Derivative Contracts:
  • A procedure for counterparties and competent authorities was introduced.
  • Practical or legal impediments to intragroup transactions were acknowledged.

10. Netting Agreements and Collateral Treatment

• Netting Agreements: These are subject to the RTS, and the application of netting is important for reducing counterparty risk.
• Segregation and Reuse of Collateral:
  • Collateral should be segregated to ensure it is not used for other purposes.
  • Reuse and rehypothecation of collateral are addressed in the RTS.

11. Initial Margin

• Timing and Settlement: The timing and settlement of initial margin are specified.
• Margin Methods: The transition to a standardised approach is outlined.
• Model Requirements: The initial margin models must meet specific requirements and be subject to model governance.
• Primary Risk Factor and Underlying Classes: The primary risk factor and underlying classes for margin calculations are defined.

12. Collateral Eligibility

• Cash Collateral for IM: Cash is eligible as collateral for initial margin.
• Eligibility Criteria for UCITS Units: Units in UCITS are eligible as collateral.
• Credit Quality Assessment: Collateral must meet certain credit quality standards.
• Concentration Limits: There are concentration limits to prevent excessive risk exposure.
• Collateral Management and Segregation: Collateral must be managed and segregated to ensure it is not misused.
• Wrong-Way Risk: The management of wrong-way risk is addressed to prevent systemic risk.

13. Haircuts

• Standard Haircuts: Standard haircuts are applied to collateral.
• Haircut Models: Haircut models can be used to determine the haircut rate, but they must be transparent and consistent.

14. Transitional and Final Provisions

• The phase-in of initial margin is designed to allow for a smooth transition.
• The phase-in of variation margin is also outlined.

15. Cross-Border Transactions

• The application of margin requirements to cross-border transactions is addressed.
• The equivalence determinations and substituted compliance are considered to ensure consistency with international standards.

16. FX Derivatives

• Scope: FX forwards and swaps are subject to the RTS, but currency overlay mandates may require exemptions.
• Exemption for Cash-Settled FX Derivatives: There was a suggestion to extend the exemption to cash-settled FX derivatives, including NDFs.
• Short Maturity Exemption: Some respondents suggested an exemption for FX derivatives with a short maturity (e.g., less than 3 months), but this was not included.
• Commercial Purpose Exemption: There was a suggestion to exclude FX derivatives with commercial purposes, but the ESAs found this distinction unclear and not supported by the BCBS-IOSCO framework.

17. Other Considerations

• The application of margin requirements at an investment-fund level is addressed.
• The sharing of margin calculation information is considered important for transparency.
• Trade documentation is necessary to ensure compliance with the RTS.

Conclusion

The final RTS reflect a balanced approach to risk-mitigation techniques for OTC derivatives not cleared by a CCP. They aim to enhance transparency, reduce counterparty risk, and align with international standards such as BCBS-IOSCO. The amendments incorporate feedback from market participants and regulatory bodies, ensuring a smooth implementation and consistency across jurisdictions.