Final Report - Managed Funds Association

cleared by a CCP, notably on capital requirements and exchange of collateral (margins for bilateraltransactions) to cover the exposures arising from those transactions and on operational processesfor the exchange of collateral, minimum transfer amount and certain details on intra-groupexemptions. All these measures are not included in this final report. The European Commissionwill have to set a new deadline for the delivery of the draft technical standards mentioned under ii)and iii) above.6. One essential element for the drafting of the technical standards is the analysis of the cost andbenefits that the proposed measures might entail. This final report includes an impact assessmentin Annex VIII. The limited amount of information available and collected on the basis of theresponses to the DP and CP did not allow ESMA to perform an in-depth quantitative cost-benefitanalysis on all the technical standards. Notwithstanding the lack of data and evidence supplied byrespondents to the CP, the cost-benefit analysis included in this final report contains quantitativeelements on many of the technical standards, in particular those that introduce prescriptivemeasures. The impact of criteria based technical standards could only be assessed on a qualitativebasis.7. Another important element signalled by stakeholders in responding to the two consultations islinked to the time needed for market participants to adapt to the new requirements. ESMA hasconsidered these concerns and has postponed the date of application of the relevant draft technicalstandards.8. This final report contains a summary of responses to the CP received by ESMA and the rationalefor keeping or changing the standards following the consultation process.Feedback from stakeholders and changes to the draft technical standardsIII. OTC Derivatives9. In developing the draft technical standards on OTC Derivatives, ESMA has considered reportsprepared by international bodies including the Recommendations of the FSB report onImplementing OTC Derivatives Market Reforms, the draft requirements for Mandatory Clearing ofIOSCO, and the Supervisory Guidance for assessing bank‟s financial instrument fair valuepractices of the Basel Committee on Banking Supervision (BCBS).10. In addition, intensive bilateral and multilateral discussions took place with third countrycompetent authorities in order to ensure, to the extent possible, convergence in the approachesadopted with the objective of preserving the global nature of the OTC derivatives market.11. These reports have provided a solid basis for ESMA which has conducted further analysis andwork to develop draft technical standards aimed at ensuring the global compatibility of the EUrequirements, thus permitting EU market participants active on OTC derivative markets tooperate on a global basis.12. Stakeholders‟ answers to the DP and to the CP, as well as relevant authorities‟ answers, allowedESMA to gather relevant information to further develop the draft RTS. ESMA has analysedanswers received to the CP and revised the draft RTS taking into account the comments providedby stakeholders and relevant authorities.7

III.I Clearing obligationTypes of indirect clearing arrangements (Article 4 of EMIR)(Annex II, Chapter II)13. Article 4 of Regulation (EU) 648/2012 (EMIR) establishes that counterparties can comply with theclearing obligation either by becoming a clearing member (CM) of a CCP authorised to clear thecontracts covered by the obligation, by becoming a client of a CM, or by „establishing an indirectclearing arrangement with a clearing member‟. These arrangements must not increasecounterparty risk and must ensure that the assets and positions of the counterparty (i.e. theindirect client) benefit from protection with equivalent effect to the client segregation andportability requirements in Articles 39 and 48 of EMIR. ESMA is required to draft RTS specifyingthe types of indirect clearing arrangements that satisfy these tests.14. The CP outlined ESMA‟s interpretation of indirect client clearing arrangements and proposed a setof requirements on each of the parties involved – CCPs, CMs, direct clients and indirect clients.The proposals were predicated on the idea that many of the provisions in EMIR regarding clientclearing should „slide down‟ one level to cover indirect clearing arrangements. This principleunderpins the requirement in Article 4 of the draft RTS for CMs to offer (via clients) indirectclients the option to have their assets and positions recorded in omnibus or individuallysegregated accounts in the books of the CM. The draft RTS also expected CMs to implement robustprocedures for porting indirect client assets and positions following the failure of a direct client,with a requirement for the CM to manage indirect clients‟ positions directly for at least 30 days ifthey cannot be ported in the usual way. The latter provision was introduced to provide a higherlevel of assurance that indirect clients would maintain access to the CCP following the failure of adirect client.15. The draft RTS elicited a very large volume of responses from a wide range of stakeholders. Anumber of respondents explicitly welcomed the concept of indirect clearing, but the overwhelmingconsensus was that some of the proposed requirements would be unworkable in practice andpotentially counterproductive. ESMA has consequently made substantial revisions to the RTS inresponse to feedback received and further analysis of policy options.16. The consultation responses identified four primary areas of concern:a.The obligation for clearing members to provide indirect clearing services on reasonablecommercial terms that are publicly disclosed;b. The procedure for agreeing contractual arrangements between CM, direct client andindirect client and the structure of guarantees between them;c.The extent to which the segregation/portability requirements of EMIR could be replicatedat CM level within the confines of national insolvency regimes; andd. The requirement for CMs to commit to manage directly indirect client positions for atleast 30 days following the failure of a direct client.17. Several responses also explicitly requested from ESMA a flexible, non-prescriptive approach tospecifying requirements for indirect clearing arrangements, recognising that these arrangementsare still under development. This view needs to be balanced against the need to ensure that thedraft RTS satisfies the mandate in the Level 1 text and places appropriate restrictions on tieredparticipation arrangements that could otherwise introduce additional systemic risks. A recital to8

the revised draft RTS clarifies that ESMA will monitor the development of indirect clearingarrangements through this lens.(a) Obligation to provide indirect clearing services18. A large number of responses challenged point a) above. There were two broad objections: that arequirement for CMs to facilitate indirect clearing services is beyond the scope of the mandateestablished by EMIR; and that denying a CM the option to decline indirect clients wouldinappropriately constrain risk management. ESMA emphasises the practical need (in line with theLevel 1 text) of ensuring that indirect clearing services are available on reasonable commercialterms, but accepts that a mandatory requirement for CMs to facilitate such services could haveunintended consequences. The revised draft RTS therefore requires CMs that are prepared tofacilitate indirect clearing arrangements to do so on reasonable commercial terms.19. A number of responses also object to the requirement for CMs to disclose the terms on whichindirect clearing services would be provided, noting the case for commercial flexibility. ESMAappreciates this concern, while also recognising the need for an appropriate degree oftransparency towards clients and indirect clients negotiating the terms of an indirect clearingarrangement. The revised draft RTS seeks to strike an appropriate balance between theseconsiderations.(b) Contractual arrangements between CM, direct client and indirect client20. Some responses (mostly from CMs) challenged the provision that would allow clients to definethe contractual terms of an indirect clearing arrangement. ESMA notes that there is an implicitunderstanding that clients would consult with indirect clients in drawing up the contracts, butequally that it is less obvious that clearing members would be involved. Several responses notedthat it would be necessary for CMs at least to have full visibility over the contractual agreementsand ideally retain scope to specify minimum requirements as a risk management tool. These viewsare reflected in the revised draft RTS.21. A number of responses also raised concerns over the scope of the guarantees between CMs, directclients and indirect clients implied by the draft RTS. One specific concern was that CMs could berequired to honour all obligations between client and indirect client, even when outside the scopeof the indirect clearing arrangement. ESMA has adjusted the draft RTS to reflect more faithfullythe „slide down‟ principle by requiring clients to guarantee the obligations of indirect clientstowards CMs. The revised draft RTS further clarifies that the scope of this requirement is limitedto obligations arising from the indirect clearing arrangement.(c) Segregation and portability22. Most responses highlighted serious concerns over the legal feasibility of the proposed approach toport the assets and positions of indirect clients following the failure of the client. The responsesalso offered a range of possible solutions, from a common EU insolvency regime to extendingCCPs‟ prot

3. Before the submission of this final report to the Commission, ESMA publicly consulted on two occasions: a. from 16 February to 19 March 2012. On the basis of the political agreement on EMIR reached on 9 February 2012, ESMA released a discussion paper1 (DP) presenting