A first consultation on risk-mitigation techniques for non-centrally cleared OTC-derivative contracts (“First Draft RTS”) under Regulation 648/2012 on OTC derivatives, central counterparties and trade repositories (“EMIR”) was published by the European Supervisory Authorities (ESAs) in April 2014. A number of respondents raised concerns regarding the proposed text, and the ESAs engaged in extensive dialogue in order to identify all of the operational issues that may arise from the implementation of the proposed framework.
On June 10th 2015 the ESAs published their second consultation on risk-mitigation techniques in which they proposed second draft Regulatory Technical Standards (“Second Draft RTS”).
"These Second Draft RTS address the concerns raised by industry and the consultation focuses only on a narrow set of topics that were not agreed following the first consultation held in April 2014."
The absence of common standards on margin requirements for non-centrally cleared derivatives across Member States can disadvantage some states and lead to the potential relocation of business activities in other jurisdiction with low margin requirements.
Therefore, in the Second Draft RTS the ESAs reviewed or clarified the following aspects of the proposed rules:
- the exchange of margins with third country entities and the treatment of non-financial counterparties;
- the treatment of covered bonds swaps;
- the timing of margin exchanges;
- concentration limits for sovereign debt securities;
- the requirements on trading documentation;
- minimum credit quality of collateral;
- initial margin models;
- haircuts for foreign exchange (FX) mismatch;
- the treatment of cash collateral for initial margin; and
- reviewed criteria on intragroup exemptions.
The proposed Second Draft RTS include a phase-in for initial margin requirements and a new phase-in for variation margin. They prescribe the regulatory amount of initial and variation margin to be posted and collected and the methodologies by which that minimum amount would be calculated. Under both approaches, variation margins are to be collected to cover the mark-to-market exposure of the OTC derivative contracts. For the initial margin, counterparties can choose between a standard pre-defined schedule based on the notional value of the contracts and an internal modelling approach, where the initial margin is determined based on the modelling of the exposures. This allows counterparties to decide on the complexity of the models to be used.
These Second Draft RTS also outline the collateral eligible for the exchange of margins and establish criteria to ensure that collateral is sufficiently diversified and not subject to wrong-way risk.
They further prescribe the methods for determining appropriate collateral haircuts to reflect the potential market and FX volatility on the collateral.
Significant consideration has also been given to the operational procedures that have to be established by the counterparties and an option has been given to apply an operational minimum transfer amount of up to EUR 500,000 when exchanging collateral.
With regard to intragroup transactions, a clear procedure is established for the granting of intragroup exemptions allowed under EMIR to harmonise the introduction of operational procedures and provide clarity on these aspects.
The Second Draft RTS also acknowledge that a specific treatment of certain products which may not be subject to initial margin requirements (such as physically-settled FX swaps) may be appropriate.
Finally, to allow counterparties time to phase in the requirements, the draft RTS provide that the standard will be applied in a proportionate manner. Therefore, the requirements for the initial margin will, at the outset, apply only to the largest counterparties until all counterparties with a notional amount of non-centrally cleared derivatives in excess of EUR 8 billion are subject to the rules as from 2020.
The consultation is open for a relatively short one month period, closing on July 10th 2015.
