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Summary of the Consultation Paper on Draft Regulatory Technical Standards for OTC Derivative Contracts Not Cleared by a CCP under Article 11(15) of Regulation (EU) No 648/2012

Core Content

This consultation paper outlines the draft regulatory technical standards (RTS) for risk-mitigation techniques applicable to over-the-counter (OTC) derivative contracts that are not cleared by a central counterparty (CCP), under Article 11(15) of Regulation (EU) No 648/2012 (EMIR). The RTS aim to implement the international BCBS-IOSCO framework, ensuring consistent application of risk management and collateral requirements across the European Union.

Main Views and Key Information

1. Scope and Mandate

• The RTS apply to banks, investment firms, insurance companies, and non-financial counterparties that are systemically important (above the clearing threshold).
• The European Supervisory Authorities (ESAs) were mandated to develop a joint product to implement the EMIR Article 11(15) provisions.

2. Structure of the Draft RTS

The RTS are structured into five main chapters and annexes:

• Chapter 1: General risk management procedures
• Chapter 2: Margin methods (standardised approach and initial margin models)
• Chapter 3: Eligibility and treatment of collateral
• Chapter 4: Operational procedures for collateral exchange and segregation
• Chapter 5: Procedures for intragroup derivative contracts

3. General Risk Management Procedures

• Collateral Collection: Counterparties must collect collateral for both variation and initial margins.
• Upfront Agreement: An upfront agreement on a list of eligible collateral is required.
• Special Cases:
  • Initial margins may be waived for certain physically settled contracts if the total is below EUR 50 million.
  • Collateral may be waived if the total is below EUR 500,000.
  • Special treatment applies to transactions with non-financial counterparties and those intermediated through a clearing member.

4. Margin Methods

• Standardised Method (Article 1 SMI): Derivative contracts are assigned to categories based on their residual maturity and underlying type, with add-on factors applied as follows:
  • Credit: 0–2 years – 2%; 2–5 years – 5%; 5+ years – 10%
  • Commodity – 15%; Equity – 15%; Foreign Exchange – 6%
  • Interest Rate: 0–2 years – 1%; 2–5 years – 2%; 5+ years – 4%
  • Other – 15%
• Initial Margin Models (Article 1 MRM): Models may be developed internally, jointly, or by third parties. The model must be calibrated using at least three years of historical data, including 25% stressed data. Recalibration is required every six months.

5. Collateral Eligibility and Treatment

• The RTS provide a list of eligible collateral, including cash, gold, debt securities from public and private entities, and equities.
• Credit Quality Assessment: Collateral takers must use approved internal models, counterparty models, or credit assessments from ECAI or export credit agencies.
• Haircuts: Haircuts are calculated based on volatility, and must be adjusted using the square root of time formula. The RTS also include specific rules for the treatment of collateral to avoid wrong-way risk and concentration risk.

6. Operational Procedures

• Collateral Exchange Process: Requires detailed documentation, consistent procedures, and robust processes for monitoring, escalation, and settlement of margin calls.
• Segregation of Initial Margin: Initial margin must be segregated from proprietary assets. This can be achieved through a third-party custodian or other legally effective arrangements.
• Treatment of Initial Margin: Collateral collected as initial margin cannot be re-hypothecated or re-pledged.

7. Intragroup Derivative Contracts

• Exemptions: Intragroup derivative contracts may be exempt from certain requirements if they meet specific conditions, including the absence of practical or legal impediments to the transfer of own funds or repayment of liabilities.
• Legal Impediments: These include currency controls, regulatory restrictions, insolvency regimes, and other limitations that prevent timely transfers or repayments.
• Practical Impediments: These involve operational, financial, or commercial obstacles that hinder the availability or use of assets for such transfers.

8. Application Timeline

• The risk management procedures, including margin collection, apply from 1 December 2015.
• A phase-in period is provided for intragroup exemptions, with different thresholds over time:
  • 2015–2016: Below EUR 3.0 trillion
  • 2016–2017: Below EUR 2.25 trillion
  • 2017–2018: Below EUR 1.5 trillion
  • 2018–2019: Below EUR 0.75 trillion
  • 2019 onwards: Below EUR 8 billion

9. Annexes

• Annex I: Mapping of probability of default (PD) to credit quality steps
• Annex II: Standard haircuts to the market value of collateral
• Annex III: Own estimates of haircuts to the market value of collateral
• Annex IV: Standardised Method for the calculation of initial margin

Conclusion

The draft RTS aim to provide a clear, consistent, and implementable framework for risk-mitigation techniques in non-centrally cleared OTC derivative contracts. They clarify the requirements for collateral collection, margin calculation, and operational procedures, while also addressing intragroup exemptions and the need for legal and practical assessments. The RTS are aligned with the international BCBS-IOSCO framework and are expected to be submitted to the European Commission by the end of 2014.