On 13 August 2015, ESMA published the Emir Review Report no.3 – Review on the segregation on portability requirements, presenting an overview of the issues encountered during EMIR implementation.
The Review covered the legal and regulatory, operational, technical and financial aspects of segregation and portability, suggesting clarifications and more granular requirements on a number of points. The changes would be essentially introduced by way of additional regulatory technical standards (RTS) and revision of existing ones.
Building on the Review, on 27 August 2015 ESMA published a Discussion Paper – Review of Article 26 of the RTS on requirements for central counterparties (No 153/2013). The paper focused on the timing necessary for a CCP and the level of margins available at CCP level to complete the transfer or liquidation of the client positions of a defaulting clearing member.
The key suggestion would be to move from a two-day liquidation period for products other than OTC derivatives (e.g. listed derivatives) to a one-day liquidation period in alignment with the US approach, together with a switch from a net to a gross account structure. In a net account structure, the clearing member only passes through to the CCP the net exposure across a set of clients, thereby retaining much of the client margin. In a gross account structure, the margins are posted in full to the CCP.
ESMA explored the imposition of different time horizons for the liquidation period depending on the structure of the accounts (gross ISA, gross OSA or net OSA), and suggested that the lowering of the Margin Period of Risk to one-day may be contingent upon certain criteria being satisfied: specifically, that a client ought to have greater security in relation to porting.
In its Review, ESMA pointed out a number of shortcomings in the current porting framework, echoed by the view of market participants that the transfer and portability of the clients’ positions and assets in the event of a clearing member default seemed unrealistic.
Some of the issues can be attributed to EMIR itself: the wording does not clearly carve out porting from national insolvency laws affecting a defaulting clearing member. This could prevent the porting of positions or the return of assets directly after liquidation. Other issues arise from the practical operational complexities to achieve porting. In most cases, the CCP is unaware of the identity of the clearing member’s clients, their positions or their assets, while the window to port positions can be extremely short.
In this context, ESMA’s sword to cut the Gordian Knot is to suggest compulsory pre-existing arrangements to ensure porting of positions from a defaulting primary clearing member to a backup clearing member.
Although currently far from clear, the broad lines of the model carry obligations for the client, the backup clearing member and the CCP. The client should be required to enter into the mandatory arrangement, the backup clearing member should irrevocably take up client’s assets and positions if the primary client member defaults, while the CCP should have the operational arrangements in place to transfer the positions and the assets within a day.
Mandatory porting represents an impending storm for the backup clearing members, as the irrevocable porting agreement will be linked to a known client, but with unknown particular positions or assets until porting actually occurs. In addition, a client member is most likely to default in the context of heavy market stress, where the remaining clearing members would be at best reluctant to take on additional risk.
The discussion around the default of clearing members remains embryonic at this stage, but it is likely to evolve and overlap with the legislative work on the default of CCPs.
Comments on the Discussion paper must be received by 30 September 2015.Contact Us