access to clearing of otc derivatives by non- members;documentation, asset protection and capital...

Access to clearing of OTC derivatives by non-members;documentation, asset protection and capital treatmentIBA International Financial Law Conference – May, 2015

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Access to Clearing - Client Clearing

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Access by non-members - focus on Client Clearing

• To comply, a party must clear at a CCP authorised under EMIR Article 14 or recognised under EMIR Article 25 to clear that class of derivatives, and listed in the register in accordance with Article 6(2)(b) either by

- becoming a clearing member

- becoming a client of a clearing member

- establishing indirect clearing arrangements with a clearing member

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Member clearing

Party A (CM)

Party B (CM)

Party B (CM)

CCP

Party B/A

CCP RulesParty A (CM)

ISDA CSA

CCP Rules

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Client Clearing – with Executing Broker

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ClientParty B

ExecutingBrokerParty A

CCPParty B/A

Client Clearing Broker

Party A/B

EB Clearing Broker

Party B/A

Bilateral Transaction (disappears once cleared transaction is registered with CCP)

Client Transaction

CCP cleared Transaction

CCP cleared Transaction

(if EB is CM)

Client Transaction

CCP cleared Transaction

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Indirect client clearing

• Last minute introduction EMIR - indirect client clearing

• Has not yet proven an effective means of access

• Various hybrids being considered

• EMIR Review expected to address

IndirectClient

Party B

ClientParty B

ClearingBroker (CM)

Party A/B

CCPParty A/B

ExecutingBroker (CM)

Party A

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Focus on access through Client Clearing - Documentation

• ISDA/FOA (FIA Europe) Clearing Addendum

• Central link between the Client and the CCP

• A “client clearing agreement” to be entered into between Clearing Member and Client

- to allow Client to access multiple CCPs through Clearing Member - to provide for margining from Client to Clearing Member- to protect Clearing Member from mismatch and other risks- to regulate Client’s ability to move positions to a back-up

Clearing Member upon Clearing Member default (porting)- To regulate default situation- Miscellaneous relationship functions

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Clearing Addendum –Architecture

Clearing Broker Client

ISDA/FOA Client Cleared OTC Derivatives Addendum

Agreed CCP Agreed CCP Agreed CCP

Agreed CCP

Service

Agreed CCP

Service

Agreed

CCP Service

Agreed CCP

Service

Agreed

CCP Service

Agreed

CCP Service

ISDA Master Agreement or

Futures Agreement

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Clearing Agreement – Key client considerations

• Notices

• Business Days

• Business As Usual Porting

• Timing for transfer of collateral

• Optional termination rights

• Clearing parameters/limits

• Segregation

• Criteria for Additional Collateral Amount

• Collateral

• Fees

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Clearing Agreement – Key client considerations - Notices

• Play a role in respect of - Collateral calls- Calls for additional collateral- Exchanges- Business as usual porting- Amendments including: amendments to clearing

parameters, and amendment of fees- Optional termination rights (including following

modification)- Focus on number og days and kind of days

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Clearing Agreement – Key client considerations – Business As Usual Porting

• Focus on- Ability- Conditions for- Timing (again notices)

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Clearing Agreement – Key client considerations – Events of Default

• Focus on- Which ones, if any, apply to Clearing Member?- Amendment/removal of grace periods- Consequences of

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Clearing Agreement – Key client considerations – Transfer of collateral

• Focus on- Timing- Business Days- Failures- Remedies- Prefunding

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Clearing Agreement – Key client considerations – Optional Termination Rights

• Focus on- Terms under which- Mutuality- Timing- Business-As-Usual Porting in notice period- Conditions for BAU Porting in notice period- Calculation of close-out amount – who and what?

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Clearing Agreement – Key client considerations – Clearing limits

• Focus on- Are there any?- What are they?- How may they be amended?- Is Clearing Broker obliged to clear within agreed limits?

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Clearing Agreement – Key client considerations - segregation

• Focus on- What kind of segregation – ISA/OSA Value/Asset?- Position on default/insolvency of clearing broker- Position on default/insolvency of CCP- Position on default of clearing broker and other client- Cost- Capital treatment- Legal opinion available?

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Clearing Agreement – Key client considerations – Additional Collateral Amount and ”excess collateral”• Focus on

• When can be called?

• What can be called?

• Cap?

• Notices?

• BAU-porting in notice period?

• Holding of on segregated account?

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Client Clearing – Key client considerations – Collateral

• What types?

• Distinguish Initial Margin and Variation Margin

• What is passed on and what is returned?

• Substitution?

• Interest?

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Client Clearing – Key client considerations - Fees

• Size

• Transparency

• Additional Costs

• Notices for amendment to

• BAU Porting in notice period

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Clearing Collateral Agreement

• Credit Support Annex (CSA) applies as separate CSA to each Cleared Transaction Set – i.e. where all Client Transaction-related CM/CCP Transactions are cleared on same Agreed CCP Service

• Purpose:

• to collateralise exposures related to each Cleared Transaction Set

• to ensure Independent Amount (initial margin) is transferred by Client regardless of Exposure to match (+ add-on) CCP IM Call

• to reflect that within Variation Margin may be “matching” or not

• to reflect different margin types for VM and IM

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Client Clearing Agreement– contractual freedom, within regulatory and CCP framework

• Client/CM relationship a bilateral arrangement, but must- respect EMIR requirements- respect CCP Rules- give client the right level of protection for its needs- at the right level of cost- lead to the correct capital treatment for client (and CM)

Margin and Segregation - EMIR Article 39 and 41

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Client Protection - EMIR on margin and segregation – Article 39 and 41

• EMIR:

- CCP shall impose, call and collect margins from clearing members on intraday basis (NB! CM may call ACA)

- CCP shall be able to distinguish clearing member assets from other clearing member assets and clearing member house account from clearing member client account (OSA)

- CCP shall be able to distinguish members’ various client accounts (ISA)

- Clearing member shall distinguish both in its CCP accounts and in its own accounts its own assets from client assets (and positions)

- Clearing member shall offer clients individual segregation of assets and positions

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Client Protection - EMIR on margin and segregation – Article 39 and 41

• EMIR Continued:

- Clearing member shall ensure that if client opts for ISA, excess margin shall also be posted to CCP and segregated

- CCP and clearing member shall disclose levels of protection and costs associated with different levels of segregation

- CCP and clearing member shall offer services on reasonable commercial terms

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Default procedures – post default portability

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Client Protection - EMIR on Default Procedures – Portability – Article 48

• CCP to have detailed procedures in place to deal with clearing members that don’t comply with participation requirements

• CCP to verify that default procedures are enforceable

• CCP to take all reasonable steps to ensure it has legal powers to 1) liquidate proprietary positions of clearing member in default and to 2) transfer or liquidate client’s position of the defaulting clearing member (porting)

• CCP must as a minimum contractually commit itself to trigger procedures for porting to a back-up clearing member

• NB Article 37(6):CCP may impose obligations on CMs such as participation in auctions of a defaulting clearing members positions

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Capital treatment of client cleared derivatives

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Capital Requirements Regulation

• Reminder G-20: Contracts that are not subject to central clearing shall be subject to stricter capital requirements

• CRDIV/CRR Purpose: contribute to reduction of systemic risk by motivating parties to clear OTC derivatives centrally if possible.

• Accordingly- Institutions must set aside significantly more capital to cover

counterparty exposure for bilateral – non-CCP cleared OTC derivatives

- Institutions that CCP clear are let off with limited capital requirements and no CVA

• Essential for institutions to get correct treatment• Exposures to CCPs by Clearing Members covered by more

favourable treatment in CRR, but what about clients and indirect clients?

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Capital Requirements Regulation – CMs exposures to CCPs

• An institution clearing as clearing member for clients may when calculating own fund requirements for exposures to the (Q)CCP apply a risk weight of 2% to the exposure values of all its trade exposures with the QCCP (Article 306.1(a))

• Risk weighted exposure amounts are the sum of exposure values (which may under certain circumstances for CM/CCP Transactions be zero) multiplied by the risk weight

• No CVA applies

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Application of Article 306 to clients as per Article 305 (”look-through”)

• NB! Definition of ”client” covers indirect clients

• As a starting point clients calculate own funds requirements for CCP-related transactions as any other exposure

• Clients may calculate own funds requirements for QCCP-related transactions under Article 306 (favourable treatment) if- Segregation to create bankruptcy remoteness in the event of

default or insolvency of CM or one or more of its other clients- Laws and contractual arrangements facilitate transfer of

positions and corresponding collateral to a back-up CM- Client has ”available” a legal opinion concluding that client

would bear no losses on account of CMs insolvency or any of CMs other clients under laws of: institution, CM and CCP, law governing transactions, law governing collateral or other

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What is required of local law of Clearing Member?

• Requirement: - Laws …. facilitate transfer of positions and corresponding

collateral to a back-up CM- Client has available a legal opinion concluding that client would

bear no losses on account of CMs insolvency or any of CMs other clients under laws of … CM

• Also remember requirement in Article 48 that CCP shall verify that its default procedures are enforceable.

• Does this require CCP to get legal opinion that laws of each CM jurisdiction would support such default procedures, including obligation to trigger transfer to back-up?

• Are such opinions made available to clients; e.g. on a ”non-reliance”-basis?

• FIA Europe has commissioned, and is commissioning ”look-through” opinions for some jurisdictions

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FIA Europe CRR 305(2)”Look-through” opinions

• Apply to prudentially regulated clients required to comply with CRD IV/CRR, and who clear contracts on LCH.Clearnet through an English Clearing Broker or a German clearing broker (new)

• Apply to individually segregated account type of clients, as defined in EMIR

• Documentation agnostic

• Split into two opinions – one applicable to the CCP and one applicable to the clearing member

• If clearing through an English or German broker at LCH and opted for ISA:2 % risk weight (if assumptions agreed)

• What about other segregation types?

• What about brokers from other jurisdictions?

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For further information please contact

Catherine Kendal Tholstrup

www.catherinetholstrup.com

E-mail: ckt@tholstrup-law.com

Tel: +45 50 10 48 14

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