- Benoît Coeuré – Member of the Executive Board & Chairman, Committee on Payments and Market Infrastructures (CPMI), European Central Bank (ECB)
- David Bailey – Director, Financial Markets Infrastructure, Bank of England
- María Teresa Fábregas – Head of Unit Financial Markets Infrastructure, DG for Financial Stability, Financial Services and Capital Markets Union, European Commission
- Verena Ross – Executive Director, European Securities and Markets Authority (ESMA)
- Kay Swinburne – MEP, ECR Coordinator, Committee on Economic and Monetary Affairs Committee, European Parliament
- Magnus Billing – President, Nasdaq Nordic
- Thomas Book – Chief Executive Officer, Eurex Clearing AG
- Laurence Caron-Habib – Head of Public Affairs, Strategy and Corporate Development, BNP Paribas Securities Services
- Jennifer Cosco – Executive Director, Government Affairs, Goldman Sachs International
- Ida Levine – Senior Vice President, Capital International Ltd.
The objective of the EMIR review is to identify any impediments to the achievement of the objectives of the EMIR regulation, namely the mitigation of counterparty risks and an enhancement of transparency in the OTC derivatives markets, while ensuring that there is sufficient proportionality. The perspective of growth and jobs is also taken into account in the review, as well as the capacity of EMIR to contribute to the mitigation of systemic risks by providing regulators with appropriate data.
Some changes to the EMIR requirements were suggested in the input received following the public consultation conducted earlier in 2015 by the EU Commission, but there were no requests for fundamental modifications of the regulation. EMIR is however not fully implemented yet; some technical standards still need to be adopted, the clearing obligation is not fully in place and some CCPs operating in Europe have not yet been reauthorized.
Four reports were published by ESMA in August 2015 covering different elements related to the EMIR review: (i) the systemic importance of the OTC derivatives transactions performed by non-financial counterparties and whether the determination of the clearing threshold should be reviewed; (ii) the margin and collateral rules that may be needed for coping with procyclicality; (iii) collateral segregation and portability requirements; (iv) issues identified during the first phase of the implementation of EMIR, which include some rigidities of the current clearing obligation and of the third country recognition process and the proposed removal of the frontloading requirement.
At the global level central clearing has progressed significantly. Around 50% of the notional amount of derivatives transactions was centrally cleared in 2014 and the proportion is growing. A stock taking exercise of the implementation of the CPMI-IOSCO Principles for Financial Market Infrastructures (PFMIs) is underway in order to review existing policies and practices in relation to CCP resilience and to identify whether more granular guidance is needed for the implementation of the PFMIs, with a particular focus on risk management and stress testing.
Different issues pertaining to the EMIR review were discussed during the roundtable.
Scope of application of EMIR requirements. According to the findings of the first ESMA report, OTC derivative transactions related to Non-Financial Counterparties (NFC) are not systemically relevant in all asset classes since they only represent a limited part of the total volumes exchanged. The need to maintain the exemptions from EMIR requirements that some NFCs and some financial counterparties benefit from was stressed, notably pension funds which are not in a position to post cash collateral. Increasing the consistency of the definitions of products and counterparties across legislations and of the scope of application of EMIR across jurisdictions was proposed. In addition, the suggestion was made to introduce more granular product-specific thresholds for the clearing obligation, based on measures of liquidity, market depth and volatility; this would help to fine-tune clearing obligations for complex products or for products with an insufficient market capacity to absorb the cleared risk of a defaulting member in particular. Moreover, the proposal made by ESMA to remove the frontloading requirement from EMIR was supported by several panellists.
Improvement of data quality and reporting. The data fields used for the collection of data should be further standardised and reporting requirements should be simplified, several panellists stressed. Simpler reporting processes, more focused on what is really useful for regulators, would reduce costs for market participants and allow regulators to identify risks more effectively, some speakers claimed. The cost/benefit impact of a possible move from double-sided to single-sided reporting (used in the US) is currently being assessed, the objective being to have more consistent rules at the global level and to facilitate systemic risk mitigation. Some panellists were favourable to such an evolution provided it can be implemented in a cost effective way, others considered that it is not a priority notably due to the IT challenges involved.
Risk management and stress testing. Improving the granularity and the transparency of the rules pertaining to this area was proposed, as well as further standardising stress testing frameworks and conducting risk management benchmarking across EU CCPs. Stress testing is indeed an instrument that may help to better identify risks and better calibrate loss-absorbency resources, and also to ensure more cross-border consistency of CCP risk management. It was also suggested that clearing members could play a more significant role in risk management, providing CCPs with guidance regarding for example the extent of their capacity to participate in default management processes in the event of a clearing member default under stressed conditions. Some international consistency issues regarding the risk management standards of CCPs were moreover emphasized, such as those related to the margin period of risk applied by CCPs. With respect to portfolio margining, some participants suggested that the EMIR provisions on required correlations should be modified.
International consistency. Several panellists stressed the need to ensure international convergence and consistency of standards. To that extend, some argued that it might make sense to have more granular rules at the international level while not lowering existing European standards.
Some other issues being considered in the context of the EMIR review were also covered. Expanding the possibility for CCPs to have access to central bank liquidity in an emergency situation was suggested. This is already possible in the Eurozone, a panellist explained, but this possibility should not be an excuse for CCPs not applying PFMI Principle 7 related to liquidity risk1, in particular as central banks will always retain discretion on the granting of such credit. CCP colleges were also considered to be an effective mechanism for enhancing the supervision of CCPs, making sure that CCPs apply robust risk management practices and increasing harmonisation in the way CCPs operate. The need for sufficient flexibility within EMIR prudential requirements was also stressed by a panellist, particularly in certain specific markets such as some commodity markets.
CCP Recovery and Resolution
The EU Commission is working on a legislative proposal regarding CCP Recovery and Resolution (R&R) which is due to be finalised by the end of 2015.
The strong connection between EMIR and the forthcoming EU CCP R&R framework was stressed by several panellists. There is a continuum that goes from CCP resilience into recovery and resolution. The default waterfall (DW) that is part of EMIR requirements already contains some recovery tools, therefore the recovery part of the R&R framework could be considered as an enhancement of the existing DW in the context of the EMIR review a panellist suggested and the focus of the new piece of legislation could be on resolution planning. A problem of terminology was however raised with regard to resolution. The concept of R&R was imported from the banking sector but the resolution of a CCP should be considered differently; given the “public service role” that CCPs increasingly play in the financial sector, a wind down is not conceivable in most cases therefore “CCP resolution” should include the possibility for the continuity of the critical economic functions (but not of the present management or of the shareholders in their present capacity). Continuity may therefore be a better term than resolution in this regard a panellist suggested. Continuity should however only be guaranteed if the business is viable, a speaker remarked.
The need to take into account the global context was also emphasized. If the EU goes forward as announced with a CCP R&R framework proposal, it will be the first region to do so; this is an opportunity to make sure that the proposal is tailored to the characteristics of EU markets, but the international principles developed by CPMI-IOSCO and the FSB should be taken into account, as well as any future international developments before the EU legislative text is adopted; otherwise there is a risk that the proposal may not be consistent with future rules developed by other jurisdictions. A policymaker confirmed that this would be the case.
Different elements of a possible CCP R&R framework were also discussed.
Appropriate toolbox. A toolbox approach seems relevant but it should be sufficiently flexible to allow the tools to be adapted to the cause of the problem i.e. the default of a member or an operational issue. The tools to be used in the latter case (non-default losses) need to be further specified a speaker suggested. The use of margin haircutting was discussed in more detail. Some industry representatives on the panel were against such measures, particularly initial margin haircutting, on the grounds that it may dis-incentivise clearing members to stay in the CCP. Others suggested that margin haircutting should form part of the toolkit for resolution authorities to ensure that these would be in an appropriate position to respond to unlikely yet unique and unpredictable market conditions. The portability of positions in the context of a potential failure was also touched upon. Some speakers also stressed that it should be made clear from the start in the R&R debate that there would be no public bail-out element at the end of a R&R process in order to ensure appropriate incentives within the CCP system.
Legal certainty and transparency. Ensuring sufficient legal certainty and transparency of R&R arrangements is essential in an international market such as OTC derivatives. Any barriers to resolution concerning e.g. clearing members that are common to many CCPs, should be known in advance. An assessment of the inter-dependencies in the central clearing network, including the common clearing membership between CCPs, is currently underway at the international level, and this should help to better identify potential contagion risks. The importance of maintaining the integrity of the rulebook throughout the recovery and resolution process was also stressed.
Responsibilities and nature of the resolution authority. The existing management and supervisory structures of a CCP should be maintained throughout the recovery phase, several panellists suggested, whereas the public authorities should take over in a resolution situation. Views were mixed as to whether this authority should be a local one, given the importance of acting quickly in such a situation, or a European one to account for the significant cross-border nature of CCPs and their members. Another issue is whether any money belonging to clients who have no direct relationship with the CCP is involved. If that is the case a public authority should be in charge of overseeing the loss-absorbency measures that may be put in place, a speaker suggested.
SummaryThe Chair opened the session by giving some background on CCPs and the topics that would be addressed during the roundtable. CCPs have always been an important part of the resilience of the financial system but they have become even more crucial with the introduction of mandatory clearing. The recent BIS estimates indicate that in 2014 around 50% of the notional amount of derivative transactions were centrally cleared, which is double the percentage before the introduction of mandatory clearing. The figure for 2015 will be even higher, showing that the implementation of mandatory clearing is progressing, but policymakers have always recognised that the push towards central clearing should be accompanied by more stringent standards for CCPs. The CPMI-IOSCO Principles for Financial Market Infrastructures (PFMIs) provide for significantly enhanced risk management and represent a very stringent starting point, provided that they are fully implemented. In Europe EMIR has for the first time introduced legally binding requirements for CCPs at the EU level.
The CPMI and IOSCO are currently undertaking a very far-reaching and wide-ranging stock taking exercise of the implementation of the PFMIs generally, and of those related to CCP risk management in particular, in order to review existing policies and practices in relation to CCP resilience and to identify whether more granular guidance for the implementation of PFMIs is needed. This stock-taking is very much centred around stress testing as an instrument to identify risk and to know more about CCP risk management, but also covers other areas such as margining and CCP capital levels. Stress testing is also an instrument that may ensure more cross-border consistency; there will be a comparison of practices in terms of stress testing which may result in more granular guidance for CCP stress testing but this has not yet been decided.
Regarding the recovery and resolution measures for CCPs, a proposal is currently being prepared by the European Commission (EC); a question is how to ensure consistency between such an initiative and what is being discussed on the same subject at the global level in the FSB, CPMI and IOSCO.
The EC is also undertaking a first review of EMIR which provides an opportunity not only to assess whether the new rules for CCPs are adequate but also to take a step back and assess this new framework from a systemic risk perspective. This discussion should also be an opportunity to review interconnectedness and procyclicality issues and more generally the macro-prudential implications of CCP risk management, which is a theme of growing interest.
1. EMIR Review
Overview of the output of the EMIR review public consultation
Several panellists stressed that the EMIR regulation is satisfactory and working well and that it was passed through an effective legislative process following the crisis.
A policymaker explained that the main purpose of the review is to identify any impediments to the achievement of the objectives of the EMIR regulation, namely the mitigation of counterparty risks and an enhancement of transparency in the OTC derivatives markets, while ensuring that there is sufficient proportionality. The perspective of growth and jobs will have to be taken into account in particular. The EC is also considering the systemic risk perspective because it is crucial that regulators are provided with sufficient data that is clean and easy to aggregate, in order to be able to have a clear view on the market, identify emerging risks and deal with them immediately. At present, there are some views that the data they are getting is not appropriate.
The EC has received close to 200 contributions to the EMIR review public consultation, which means that it gives rise to much interest, the policymaker emphasized. No-one is contesting in these contributions the essential principles of the EMIR regulation, which is positive. EMIR is following international principles because derivative markets are global and the EC will try to follow through this convergence at the implementation level.
A public representative agreed that generally there has been little complaint about the operation of EMIR and few requests for change. There have been some suggestions to enhance or tweak certain parts of the regulation in areas such as data standardisation and requests to simplify data fields. These are relatively limited operational issues. The other element that needs to be looked at are the exemptions from mandatory clearing in the regulation; these were temporary but the feedback is that ultimately these exemptions are probably going to need to be permanent as it is difficult to envisage alternatives.
An industry representative noted that even if the regulation is well crafted and that there is not a big case for EMIR to be significantly changed, many operational improvements are needed, as always, following its implementation. Moreover the authorities could have had more willpower in rolling out this regulation, the speaker believed, with regard to the timeline for the clearing mandate for instance.
A regulator emphasized that EMIR has already been successful in addressing financial stability risks. The resilience of CCPs has been significantly raised across the board, which represents a major enhancement.
Some panellists noted that EMIR is not fully implemented yet. Some technical standards are still in the pipeline for adoption; the clearing obligation is still not in place in the market even if the first clearing obligations have been adopted; some CCPs operating in Europe have not yet been (re-)authorized; and the discussion about international convergence as well as some recognition procedures for third-country CCPs is still underway. Many issues therefore remain to be addressed before EMIR has a full impact in the market.
The EMIR review process shows the importance of public consultations following the implementation of such a regulation, a policymaker believed. It is necessary, in doing so, to clearly distinguish the Level I legislation, which is setting objectives, from the Level II requirements, which define the more technical elements of the implementation and allow taking into consideration the specific circumstances of the market. The contributions to the EMIR review will also be considered in this perspective. If there are changes to be made, it is not yet possible to say whether they have to be made at Level I or Level II.
A regulator presented the views of ESMA on what has worked well so far in the operation of EMIR and whether there are any changes needed. At the request of the EU Commission, ESMA has published four reports that answer the different parts of the EMIR review questions. ESMA is also very active in the international arena, discussing these very technical elements, with the aim of convergence.
The first ESMA report focuses on the systemic importance of non-financial counterparties. This relates to exemptions from central clearing and whether they work properly. The importance of non-financial counterparties in different markets has been quite thoroughly evaluated and the conclusion is that overall they are not that significant from a systemic perspective given their outstanding volumes, except for a couple of specific asset classes such as commodities and foreign exchange. ESMA also assessed how counterparties are currently classified, and whether this classification is consistent across Europe. It was found that this is not always the case and points such as the hedging definitions have led to some significant divergences across Europe in terms of who is actually classified as a non-financial counterparty and where the threshold is. Some recommendations have been made for how that could be improved going forward in order to try to have a more consistent definition that actually assures that there is a common approach across Europe, but also to make sure that ultimately some of the people who are not big players in the markets do not face some of the requirements of EMIR in the same way. At the moment the "capture" of the regulation seems rather uneven.
The second report is on procyclicality. It analyses the requirements and the different options adopted by CCPs in practice to limit procyclical effects on margin requirements and collateral used to cover margin requirements. ESMA recommends in particular further specifying the rules for implementing the counter-cyclical tools for margins and collateral, including regular testing and transparency of the results.
The third report on the segregation and portability requirements in EMIR has two main objectives. First, it serves as a response to the EU Commission’s request on collateral margining and securing arrangements. The report indicates that the Regulatory Technical Standards (RTS) on CCP requirements provide sufficiently granular detail on collateral margining and securing arrangements; although some differences in implementing those requirements across CCPs have been identified by ESMA, the report suggest that they could be addressed by supervisory convergence activity. There is probably no need to make significant revisions to the RTS in this respect although this could be a possibility. The second objective is to address the arrangements to secure client collateral and more specifically the arrangements related to segregation and portability for which ESMA has a particular mandate to draft a report2. The report also elaborates on the conflict of laws with regard to insolvency, in relation to which ESMA suggests to clearly indicate the rights attached to each account structure, to use different margin periods of risk and to incentivise more secure account structures overall. In this context, ESMA has also just published a discussion paper on the issue of margin periods of risk for CCPs3. That is very much in connection with the global and international discussions on the comparability of different margin systems used by CCPs across the US and Europe in particular. ESMA has put forward a few ideas on how the system in Europe may be reviewed now that there is actual evidence on the ground that the US system and the EU system may actually lead to different results e.g. depending whether gross or net are used in the accounts structure to record client positions and calculate the corresponding margins. ESMA is open to a review of these issues if it may help to improve the overall international consistency.
The fourth report covers areas where there has been some experience with the implementation of EMIR. One issue is the clearing obligation where it is suggested that the current process is very rigorous and rigid. The impossibility to suspend the clearing obligation or to change it in any way in a period of major market stress is a real risk. At the moment there is no tool in the European framework for doing that and such a tool is necessary in order to be more agile in managing the clearing obligation in the necessary circumstances. There is also an argument for removing the frontloading requirement4, due to the legal uncertainty it creates until the relevant RTS is finalised and to the difficulty of applying a frontloading requirement during the phase-in time needed to implement the clearing obligation. Another issue is the recognition of third country CCPs. The recognition process was longer than hoped and expected, but the main problem is its rigidity and the limits put on the conditions that can be evaluated by ESMA, which need to be reconsidered. Finally, there are also some issues about the day to day supervision of Trade Repositories and the enforcement measures that can be taken, which are worth reviewing from a practical perspective. Those are the key areas that ESMA has identified in the EMIR review and ESMA will obviously work very collaboratively and actively over the next few months with the EU Commission and the co-legislators to see what should be changed.
Regarding mandatory clearing, an industry speaker agreed with the approach of removing the front loading obligation, as re-pricing contracts at a later stage after moving them to CCPs would be "a nightmare". Whilst some progress has been made in the draft Delegated Act regulation proposed by the European Commission regarding the clearing of interest rate swaps, fully removing the front loading obligation would be the right approach. Another industry speaker agreed that whilst it is hard to undo what has already been done, it is worth considering revisiting the front loading obligation for future asset classes and currencies in particular as there may be more complexity in the future.
Comments made on specific aspects of the EMIR review
Scope of application of EMIR and exemptions for non-financial firms
The exemptions from EMIR requirements are a first priority of the EMIR review, a public representative mentioned; how to make some of the exemptions permanent; how to make sure that pension funds in particular, that are not in a position to actually post cash collateral, stay outside of mandatory central clearing and how to make sure that the end users, the corporate treasury teams, actually have a fair system in which to operate and are not "caught" by EMIR requirements when that is not necessary. An industry representative emphasized that maintaining the current exemption that pension funds have from EMIR requirements is very important.
An industry representative asserted that the consistency of the scope of application of EMIR and of the definitions made in the regulation are a key priority for the industry. This applies to the counterparties to OTC derivative contracts and notably to non-financial counterparties. There are some issues regarding non-EU counterparties as well, since in some cases it is difficult to know if they are non-financial or financial players, so this needs to be clarified.
Further clarity is also needed regarding the scope of products EMIR requirements apply to. EMIR makes reference to MiFID for the definition of derivative contracts, but there are some differences in interpretation across EU member states and also with non-EU counterparties because definitions outside Europe differ, especially in the US.
The example of power markets and more specifically the Nordic electricity market that is 90% cleared today in CCPs was stressed by an industry representative; market participants are non-financial firms such as producers and distributors. Since they cannot build up a balance sheet similar to that of a bank, they borrow the balance sheets of financial institutions to be able to fulfil clearing requirements with CCPs. This is a model that has been working for a number of years and has been through stress scenarios on several occasions. EMIR intended to allow commodity markets to continue operating in the same way for a transitional period, which was sensible, but that transitional period should be extended further. Otherwise, there is a risk that this Nordic electricity market which is already centrally cleared will become bilateral because non-financial institutions do not have the appropriate balance sheet.
Reporting and data quality
The improvement of data quality and reporting is a second key topic of the EMIR review, a public representative stressed. Standardisation must be at the core of the data quality discussion and data fields for the collection of the data must be simplified. This simplification must be done not just on a European basis but also across the globe in order to converge towards one system of data fields; this is necessary to make sure that the data is usable by regulators. Data is essential for the functioning of the market in the future and the first step is to actually achieve the appropriate level of standardisation and simplification.
An industry representative agreed that ensuring the quality of data is a priority. Simplification is also important and making sure that all the fields which are required provide real value for the supervisors. If it is agreed that some information is not needed and will not help regulators and supervisors to assess systemic risks, then those fields should not be kept in the reporting.
Another industry speaker confirmed that simplified reporting would be much appreciated. The reporting regime has been very difficult for some of the buy-side participants, as there are costs involved, so the simpler the better. Simplifying reporting is a win-win evolution because having reporting that is not really useful creates "too much noise" and makes it difficult for regulators to really be able to identify the problems. Definitions need to be reviewed in that context, for example the definition of a spot versus a forward, which are methods of trading, is also important for the reporting.
Another issue in this context is the possible move from double-sided to single-sided reporting.
A public representative explained that this is a challenging issue. Industry players have now invested in IT systems, and those who have invested do not want to go back to single-sided because they have got double-sided working. This must be examined in an analytical way to see how things are working, what the cost / benefit elements are and whether or not there really is a good reason why there should be a change from double to single. If the cost / benefit analysis and the rationale behind it make sense, it should be changed.
An industry representative believed that quality of data should be the main priority. The main issue is not the shift to one-sided reporting.
Other industry speakers were more favourable to a possible shift to single-sided reporting. The fact that the industry is doing a great deal of work to develop a blueprint around a transition to single-sided reporting that is cost effective but ensures that regulators receive the amount of data necessary to detect systemic risks and resolve disputes was stressed.
Risk management and stress testing processes
Risk management and stress testing processes are important topics that are being assessed in the context of the EMIR review. Different aspects were developed during the roundtable.
A first issue is the granularity of the rules, a regulator emphasized. The PFMIs are extensive but there are still areas where they would benefit from further granularity. That is something that CPMI - IOSCO are already looking at, particularly areas such as stress testing, the amount of capital that CCPs put into the default waterfall, which is very important because of the incentives it provides the owners of CCPs with, and the calculation of the size of pre-funded financial resources. When the international standards are amended then they must be taken into account in European legislation.
The possible increase of loss absorbing resources is a second issue that should be considered, an industry player considered. These resources should be calibrated through a standardised stress testing and risk management mechanism. The amount of clearing member contribution should be risk-based and provide enough skin in the game so that they are incentivised to "really pay attention" to risk management. The more capital is required for CCPs and their clearing members, the more costs go up. It is necessary to avoid a situation where market participants do not have the incentive to use hedging and other risk management tools when investing, so there is a balancing act. A harmonised network of prudential regulators beyond the EU should be established to address such questions, since the main CCPs, their clearing members and the clients of the clearing members are all international, the speaker suggested.
Another industry player added that even if default waterfalls and margin methodologies are important, it is essential to keep providing incentives for CCP clearing. Some market participants already consider that CCP services are too expensive and not worthwhile using and instead give up hedging or go bilateral. There need to be mechanisms in place to ensure that incentives are there for CCP clearing in order to fulfil the obligations that were set six years ago.
The transparency of CCP risk management processes is a third issue, an industry representative stated. This concerns notably stress tests, margin methodologies and default funds. Clearing members have an important role to play regarding risk management, the speaker suggested, potentially providing guidance to CCPs as to how much they could safely clear in times of market stress. Clearing members are implicitly, though not contractually, obliged to assume a defaulter’s cleared risk by providing hedges or bidding in auctions, but when the defaulter’s cleared risk exceeds the market’s capacity to absorb it, that puts clearing members in a potential unlimited liability situation. In order to effectively mitigate systemic risks, regulators could consider requiring clearing members to provide clearing member risk thresholds that would serve as baseline limits for how much each CCP could safely clear for a given risk type. This would, of course, need to be allocated across CCPs and product types but this is a critical part of ensuring a resilient and robust CCP. Another industry speaker pointed out that the transparency of CCPs, especially as regards margin methodologies or default funds, was high and clearly visible for market participants.
A regulator agreed that the governance of CCPs is very important and that clearing members have a responsibility in risk management. A difference should however be made between clearing members and indirect members, such as pension funds for instance, which cannot be liable to the same extent since they are not involved in the decision process to the same degree.
An industry representative suggested further standardising the stress testing of CCPs and benchmarking CCP risk management processes. Having a template for stress testing and testing CCPs at set intervals so that there is real certainty and structure around this process would be useful. The results should be very transparent and disclosed not only to regulators but also to the market and market participants. This would help asset managers in particular to conduct their due diligence regarding CCPs, on behalf of their clients, which is an important aspect of the protection of client interests.
Stress testing is an area that has not yet been covered in great detail regarding CCPs, an industry speaker noted, and where there should be a global approach in order to avoid the consistency issues experienced in other areas of CCP legislation. The interconnectedness across CCPs needs to be taken into account in this context.
The international consistency of EMIR requirements is another "great challenge", an industry representative pointed out. Although they are well crafted, many standards are not consistent with some of the agreed international standards. The most prominent example is the margin period of risk5. What has been set out in EMIR is the better approach, it is a very prudent policy decision notably with a two day standard for the liquidation of the positions of a defaulting clearing member for instruments other than OTC derivatives, the speaker believed. It would be good to see these standards being maintained while making them compatible with the international ones6. There are ways to create incentives for prudent regimes on client margins if issues around portability and segregation are dealt with in an appropriate way. The recognition of third-country CCPs operating in the EU, which are supposed to meet European standards, is a challenge in this regard; the "bottom line" however is that Europe has adopted the highest standards in many areas which ensure the resilience of EU based CCPs.
Clearing obligations and product suitability for clearing
From a clearing member perspective, there are some additional safeguards which can support CCP resilience and are worth considering at the global level and in EMIR, an industry representative emphasized. The first one is product suitability. There is already a very robust process in place, in particular at the European level, but regulators should consider going further and adopting more granular product-specific thresholds based on measures of liquidity and market depth. One application of this would be potentially stipulating tolerable levels of volatility risk for some of the more complex products that may be coming down the pipeline, once the clearing mandate begins. Further granularity would also help regulators to identify the products for which the market capacity may be too limited in times of stress to absorb a defaulting member’s cleared risk and for which a clearing mandate may not be appropriate.
Indirect clearing is another issue for which there are still many uncertainties that remain to be tackled from a legal and operational perspective, an industry representative emphasized. It should be ensured that indirect clearing will not be mandatory in any case and that it will only apply when all parties to the transactions are located in the EU, otherwise it will not be possible to apply the corresponding provisions. A key area of concern is the articulation with the prudential requirements for clearing members, which are not the right incentives to promote the development of indirect clearing.
The cumulative effects of EMIR and of other post-crisis regulations need to be considered, a member of the audience pointed out. An appropriate calibration of the leverage ratio and of the regulatory capital regime is necessary to ensure that banks have sufficient balance sheet capacity to provide access to clearing for their direct clients, but also for indirect clients. After a period of implementation there is a need to step back and assess whether the right incentives have been created with the different strands of regulation, a regulator agreed. A number of international bodies such as CPMI, IOSCO, FSB and the Basel Committee are currently working on these issues.
Central bank liquidity
The liquidity aspect is extremely important, an industry representative emphasized, even if a CCP has a strong default waterfall and a capital base to protect it and the market from a stress situation. There are certain examples in Europe today where central banks are providing access to liquidity for CCPs in an emergency situation. That is a very good mechanism, but not all CCPs have this possibility today. Expanding it across the EU should be considered as part of the EMIR review notably to ensure a level playing field.
With regard to central bank liquidity, it should be possible for central banks to provide liquidity to CCPs in an emergency situation and that is possible actually in the Eurozone, a regulator pointed out. The Governing Council of the ECB can decide to provide liquidity to an euro-area CCP even on an ad hoc basis and even for CCPs that are not banks. However, that cannot be an excuse for not complying with the PFMIs and, in particular, Principle 7 on liquidity risk7 as well as with EMIR, with pre-arranged and highly reliable funding sources. Also, there should be no technical obstacles to cross-border and cross-currency liquidity provision to CCPs. There is now such an arrangement between the ECB and the Bank of England for certain CCPs. It is a very important step forward to have this kind of liquidity arrangement but again that cannot be an excuse for not complying with the PFMIs as well as with EMIR, and as always, central banks maintain their discretion when it comes to granting credit. Another speaker pointed out that it would also be sensible to ensure CCPs’ access to central bank liquidity in non-stress times, as this would facilitate obligations in the context of risk management.
A regulator emphasized that the way that the authorities across Europe have come together in college arrangements has been "a critical element" in the enhancement of CCP resilience with EMIR. From a UK perspective, the Bank of England is a great supporter of college arrangements for CCPs operating in multiple jurisdictions. Colleges have been established at the global level for CCPs based in the UK, bringing in regulators from across the globe. What EMIR is doing is to establish a similar approach from a European perspective; that has really helped to enhance supervisory convergence and make sure that standards are widely being improved. The process is not perfect, and that can be reconsidered at a technical level in the EMIR review, but there has been a major enhancement.
The introduction of a college mechanism with EMIR is a positive evolution, an industry representative agreed, since it fosters standardisation and harmonisation in the market and in how CCPs operate. There should however be enough flexibility to be able to consider the features that are specific to certain CCPs or markets. Commodity markets are an example where there are major specificities; the Nordic electricity market for instance is 90% cleared today in CCPs and market participants are non-financial firms such as producers and distributors.
2. CCP Recovery and Resolution
The Chair moved the discussion to CCP Recovery and Resolution. The EU Commission is working on a legislative proposal; the aim is for it to be adopted by the end of 2015.
Interactions between EMIR and Recovery & Resolution (R&R)
Several panellists emphasized the strong connection between EMIR and Recovery & Resolution. There is a continuum that goes from CCP resilience across into recovery and resolution.
A policymaker explained that the EU CCP R&R framework should build on EMIR, because EMIR forms the basis for CCP requirements. Some tools have also been elaborated in the context of the Banking Recovery Resolution Directive (BRRD). In terms of process in the EU Commission, the experts on CCPs and the experts on recovery and resolution are working together in order to make sure that the legislation will be fit for purpose and that existing law has been taken into consideration.
A public representative pointed out that the default waterfall that is in EMIR already contains some recovery tools8; "how deeply it already goes as a tool" should not be understimated. Mandatory clearing is being implemented for a large number of instruments and a large number of entities, making CCPs almost public service entities, therefore a default waterfall was needed in the EMIR regulation. The EMIR review should already include most of the enhancements needed with regard to recovery with the review of the default waterfall. It is therefore questionable whether the new piece of legislation on CCP Recovery & Resolution (R&R) needs to encompass recovery as well as resolution. From a legislative point of view these two initiatives should not be separated quite so much and should be considered holistically. The units working at the EC on the two pieces of legislation need to collaborate. Recovery could be considered as a part of EMIR, and then resolution and continuity plans could be the actual focus of the new piece of legislation being developed. Moreover it is quicker to review EMIR than it is to start with a completely new piece of legislation. There is a tendency to talk about recovery and resolution together because this is the terminology used for banks, which obviously need to have both, whereas regarding CCPs the recovery tools have already been considered as part of EMIR and continuity is essential. An industry speaker agreed that the business models of banks and CCPs are very different and that this must be respected; CCPs are exposed to highly concentrated risk and act as risk neutralisers.
A regulator agreed that risk management starts with EMIR and that R&R is only there to cover residual risk. Consistency is therefore needed between the EMIR review and any Recovery and Resolution proposal. In this respect, the parallels made with CRD IV and the BRRD may be misleading to a certain extent.
An industry representative agreed that the key legislation for elaborating the CCP R&R framework and reviewing the definition of the default waterfall is EMIR, although there is certainly a need to address other issues such as the mandate and the tools for resolution authorities.
An industry representative stressed that resilience is the most important issue for CCPs. A recovery or resolution scenario must be avoided as much as possible and the industry is ready to do all it can to ensure this. Although asset managers are not part of the clearing infrastructure they are very interested in its safety and making sure that the right incentives are created. Resilience should the first line of defence and this should be the first priority of the on-going work related to CCPs. Another industry representative concurred that while CCP R&R is very important, it is also essential to go back to first principles and focus on ensuring CCP resilience. This is why the work of CPMI-IOSCO is so critically important; it is about ensuring that the mandatory clearing requirement reinforces the robustness and resilience of CCPs, so they never get to a point of failure where recovery or resolution may be needed.
Another industry representative agreed that the key principle has to be continuity, but those benefiting from continuity, both owners and users should pay for it. In terms of incentivising prudent risk management, this should very clearly rule out any funds from anywhere else. First of all taxpayers funds, or any central bank funds, because that is the clearest way to incentivise everyone to come to a conclusion in the recovery phase and to find a solution. Continuity will be achieved if there is viability, otherwise the market has to be wound down if nobody wants to recapitalise it.
A regulator stressed that EMIR put specifications around the pre-funded default resources that CCPs need to have, but it did not go as far as specifying the recovery tools that CCPs should have in place. The continuum needs to work together so that CCP recovery measures and CCP resolution measures incentivise the owners and the users of CCPs to ensure that CCPs are robust, i.e. that the recovery and resolution tools will not be needed. The EMIR review and the CCP rules should be considered in conjunction with the developing proposal on CCP recovery and resolution to ensure that they work together.
The regulator added that the point of entry into resolution cannot be defined ex-ante in a "hard-coated way". The particular situation that the CCP is in must be carefully considered and a judgement-based approach is needed to decide to put a CCP from recovery into resolution. It is very important that the legislation caters for that point. A member of the audience considered that the identification of the point of non-viability of CCPs should be part of the discussion on CCP resolution. It is true that there is a need for the resolution authority to have maximum flexibility, however defining the point at which there is a move to a special resolution regime is quite important in order to have some degree of certainty ex-ante, particularly for end users who are forced into the system by regulation. A policymaker considered that the question about the point of non-viability precisely stresses the fact that when drafting any proposal there must be legal certainty at all levels.
A bank resolution perspective needs to be included in the CCP R&R debate, with an involvement of the Single Resolution Board (SRB) for instance, an industry representative suggested. CCPs will be very strongly impacted by actions taken on the banking side given their membership. It will be important to know to what extent banks can actually provide support to a CCP, because many of them will probably say they cannot do so. There needs to be pre-clarity on the support that banks may be able to provide, which can be supported by stress simulations, and on the funding that might be needed.
Taking into account the global context when drafting the CCP R&R proposal
A public representative stressed that the global context is a key element to take into account. The "worst case scenario" would be for the EU to be front running the global work and then ending up with a very rigid framework that is not flexible enough to conform with the global standards. Some of the legislation in Europe indeed ends up being very rigid; this is in particular because it is not always easy to find the right balance between Levels I and II and the output of the co-legislative process is quite uncertain sometimes. Ways must therefore be found in Level I of the CCP R&R framework to ensure that the framework is sufficiently flexible.
A regulator agreed that the consistency between the European process and the global process is essential. Europe could be a first mover with the CCP recovery and resolution proposal currently being developed, which might be available before any of the partners of the EU have their own legislation. This is an opportunity to draft it according to the needs and characteristics of European markets and infrastructures, but there is also the responsibility to design it consistently with FSB principles and in a way that can be followed by other jurisdictions.
A policymaker confirmed that the CCP R&R proposal will take into account all the international principles and discussions (i.e. the international level involving the FSB, CPMI, and IOSCO, which have already produced some guidelines).
A regulator emphasized the importance of international consistency. There is sufficient international guidance from CPMI-IOSCO on recovery and from FSB on resolution to form the basis of a legislative proposal for CCP R&R in the EU. However, negotiating a piece of legislation takes time and further guidance will be developed by CPMI-IOSCO and the FSB. So if the process starts soon in Europe it should keep in line with international consistency to avoid some of the problems that have been seen with EMIR. International co-ordination is also essential in the implementation phase. Colleges for CCPs have been successful under EMIR. It is important to have mechanisms like that for resolution. Crisis management groups can be put in place, which could work alongside colleges to make sure that there is international consistency and co-ordination if a CCP is being entered into resolution; the implications on all the jurisdictions that will bear the impact should be well understood and catered for.
A regulator agreed with the need to follow and work with the international standards as they are developing, because this is about developing a global regime. Lessons can be learned from what is being designed at the international level and there needs to be a strong alignment.
The issue of terminology differences was stressed by a public representative. In Europe, the recovery plans are drawn up by the CCPs, while the resolution plans are drawn up by a resolution authority, but that is not the case globally; in many other jurisdictions around the world resolution plans are drawn up by the CCPs. It is important to be careful that everyone is talking about the same concepts and to ensure that there is a global level playing field. Terminology is also problematic in other respects in the international context. When resolution was being discussed in the EU Parliament the term did not necessarily refer to a wind down of the CCP, it included the possibility for the continuity of the business, whereas in the banking sector resolution means a physical wind down of the bank. Some CCPs are indeed now public service entities that are so important that they cannot be allowed to be wound down. A way must be found to provide business continuity. Continuity suggests that the business of the CCP needs to continue for the public service it is providing, but does not mean that the existing shareholders of the CCP will continue to have a say or a role, or that the current management is maintained. Continuity is therefore, in some respects, a better term than "resolution", the public representative believed. But in conversations at the international level it is very important to make sure that we are talking about the same thing.
Key issues to be taken into account or worked on in the perspective of a CCP Recovery & Resolution framework
The Recovery & Resolution toolbox
A toolbox approach is needed for the recovery and resolution of CCPs, but there must be sufficient flexibility in the capacity to use the instruments, a public representative emphasized. Establishing ex ante prescriptive rules for when and how to use recovery tools should be avoided. It should be for those "on the frontline" to do so, depending upon the cause of the problem e.g. the default of a member or an operational issue. Different tools might be used so there must be flexibility.
Some tools, such as the haircutting of margin, initial margin and variation margin, could undermine the use of CCPs an industry representative believed. Asset managers who use CCPs on behalf of their clients would be particularly unfavourable to the use of initial margin, which may create the wrong incentives, encouraging the participants to leave the CCP early rather than staying in close-out positions and could be procyclical. Another panel participant disagreed with this view and pointed out that it is important to ensure that resolution authorities are in an appropriate position to respond to unlikely yet unique and unpredictable market conditions. Therefore initial margin as well as variation margin haircutting should form part of the envisaged toolkit for resolution authorities. The speaker further noted that it is also important to consider the differences between initial and variation margin haircutting, i.e. while the former would ensure an equitable allocation of losses based on the respective risk profile of the relevant market participant, the latter would likely lead to stronger hits on large directional portfolios (such as pension funds and insurers).
Also portability was discussed. An industry representative noted that it was important for users that if there is a problem they need to be able to go to other CCPs and continue their hedges and their risk management in the portfolios.
Margin and capital have different objectives. Margin is designed to secure a transaction, not to create a buffer. Initial margin haircutting should be avoided, an industry representative agreed, because of the wrong incentives it creates.
Another industry speaker was also concerned by the possible use of margin haircutting, but suggested that variation margin gains haircutting could be used in a limited capacity; there are however many other tools that can be used.
A regulator added that recovery tools and resolution tools need to incentivise prudent risk management and that recovery tools need to work in a way that does not inhibit resolution, should it be needed.
The toolbox that is needed for non-default losses (i.e. those that are not related to a clearing member default) should also be considered and further assessed, an industry speaker believed. For such losses there should be a differentiated approach; a waterfall process would not be appropriate in particular.
Legal certainty and transparency
Legal certainty is another sensitive issue at the international level a public representative believed. Given the cross-border nature of CCPs and the global presence of their general clearing members, there must be sufficient legal certainty in resolution. Many CCPs across the globe have common clearing members; it is therefore necessary to be aware of whether or not there are any constraints upon any of them to participate in some of the locally devised CCP resolution plans. If there are, these constraints must be known in advance, for example if the home competent authority prevents for any reason a clearing member from participating in certain tools part of the toolbox. That legal certainty and advance knowledge of any barriers to resolution is very important particularly in a crisis situation and therefore contingency arrangements need to take this legal environment into account. Ideally, there should be a global mapping exercise of all the possible contagions between the clearing members that are common to CCPs. It would indeed be important to know where risk lies and how many CCPs are affected if a major CCP runs into difficulty. It may be a tail event, but "there must be a plan" and planning reduces the probability of a default.
A regulator mentioned that a study group comprising CPMI, IOSCO, BCBS, and FSB representatives is currently working on central clearing inter-dependencies and that it should have some first results in 2016. It is quite a demanding exercise, but it is being done.
When recovery and resolution are considered from a clearing member perspective, an industry representative emphasized, maintaining the integrity of the rulebook is paramount to ensure that there is certainty over what is happening once a CCP has entered into the default fund stage and then throughout recovery and resolution if that is the case. Another industry speaker added that the key priority is to have transparency on the recovery and resolution plans. This has to be done ex-ante and not ex-post for clearing members to be able to assess their level of risk and exposures to the CCP. Second, since clearing members have to contribute to ensuring the continuity of the CCP, they want to be sure that their contribution will be kept to avoid a contingent risk, because otherwise it would not be the right approach.
A member of the audience remarked that portability and the on-going existence of trades following the default of one of the counterparties could potentially be challenged under insolvency or property laws. It is important to clarify the extent to which EMIR and MiFIR may override traditional insolvency and property laws for indirect clearing.
Responsibilities and nature of the resolution authority
During a recovery phase, responsibilities should be very closely linked to the day to day supervision of the CCP and of the EMIR standards, a regulator considered. Therefore, the mechanisms in place seem to be the right ones to follow. In a resolution situation, some additional factors need to be taken into account. How to make the system and the roles and responsibilities work in such a situation and, in particular, how to ensure consistency across Europe so that there is a fair and effective approach to resolution needs to be carefully examined.
An industry representative agreed that the recovery phase should be driven by the CCP. Moreover, resolution should only be triggered after all the recovery tools have been exhausted. On the resolution side, it is important that there is one authority taking control of the process and this should be a local one. Speed is indeed of the essence in such a situation and this is difficult to achieve with a college of supervisors.
Another industry representative considered that domestic and EU supervisors will be very involved in the recovery process as well. It is important to ensure that there is a public body overseeing the different recovery tools and the client money.
A regulator stressed that the responsibility for making sure that CCPs are resilient does not just reside with the owners of the CCPs; it resides with the members as well. They need to work together to ensure the resilience of the CCP. A regulator moreover expressed a preference for a European resolution authority to account for the significant cross-border nature of CCPs and their members.
Another element to be considered is whether any client money is involved, a public representative stressed. The clear message from the EU Parliament’s own initiative report back in 2012 was that any use of end-client money, belonging to clients who do not have a direct contractual relationship with the CCP or who do not have a role in the governance of that CCP's management structure, needs to be overseen in some way by a public body. If client money is going to be redistributed - and there are various mechanisms in the toolbox to do that - then a third-party needs to be overseeing that it is being done in a fair and equitable way with regard to those end clients.
Governance must protect clients’ money and international consistency is paramount, an industry representative agreed.
1 Which requires CCPs to effectively measure, monitor and manage their liquidity risk
2 The rationale behind the provisions on segregation and portability is to ensure some level of protection for clients of clearing members through specific records of positions and assets given as collateral (except for default fund contributions). The most protective scheme allows clients to be immune to their clearing member’s default as much as possible through transfer of positions and assets to another clearing member or a separate liquidation of their positions and return of any proceeds. For further information see ESMA EMIR Review Report N°3 https://www.esma.europa.eu/system/files/esma-2015-1253_-_emir_review_report_no.3_on_segregation_and_portability.pdf
3 ESMA published in August 2015 a public consultation on the review of Article 26 of its Regulatory Technical Standards (153/2013) under the EMIR Regulation which deals with the liquidation period (margin period of risk - MPOR) that clearing houses (CCPs) need to apply to client accounts. https://www.esma.europa.eu/news/ESMA-consults-review-EMIR-standards-relating-CCP-client-accounts
4 Article 4(1)(b)(ii) of EMIR requires that under certain conditions, even contracts entered into or novated before the date from which the clearing obligation takes effect get cleared. More specifically the requirement is to clear contracts entered into or novated on after the notification of a CCP authorization but before the date from which the clearing obligation takes effect. For further detail see ESMA Review Report 4 at https://www.esma.europa.eu/system/files/esma-2015-1254_-_emir_review_report_no.4_on_other_issues.pdf
5 The margin period of risk is the time period from the most recent exchange of collateral covering a netting set of transactions with a potentially defaulting counterparty until the transactions are closed out and the resulting market risk is re-hedged.
6 A critical difference that has emerged between the US and EU regimes in the debate on the equivalence between legal and supervisory arrangements for CCPs is that for US CCPs the minimum liquidation period for financial instruments other than OTC derivatives is one day, although applied for client accounts on a gross basis, whereas under EMIR the minimum liquidation period is two days, but margin may be provided on a net basis for clients booked on one omnibus account.
7 PFMI Principle 7: An FMI should effectively measure, monitor and manage its liquidity risk. An FMI should maintain sufficient liquidity resources in all relevant currencies to effect same-day and, where appropriate, intraday and multiday settlement of payment obligations with a high degree of confidence under a wide range of potential stress scenarios that should include, but not be limited to, the default of the participant and its affiliates that would generate the largest aggregate liquidity obligation for the FMI in extreme but plausible market conditions.
8 Not all the default waterfall is considered to be part of the recovery toolkit. In addition residual loss allocation is not explicitly covered in EMIR
By B. Cœuré - Member of the Executive Board, European Central Bank (ECB) & Chairman, Committee on Payments and Market Infrastructures (CPMI)
By V. Ross - Executive Director, European Securities and Markets Authority (ESMA)
By L. Caron-Habib - Head of Public Affairs, Strategy and Corporate Development, BNP Paribas Securities Services
By Dr K. Swinburne - MEP, ECR Coordinator, Committee on Economic and Monetary Affairs, European Parliament
By M. Billing - President, Nasdaq Nordic
By M. T. Fábregas - Head of Unit Financial Markets Infrastructure, DG for Financial Stability, Financial Services and Capital Markets Union, European Commission