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RRP: Shining a Light on Financial Contracts

Introduction

As a firm, do you know the detailed contents of your portfolios of derivatives and securities financing contracts?  The Bank of England[1] wants to know, and will soon have the power to compel you to provide this information.

The Bank Recovery and Resolution Directive (“BRRD”) mandates competent authorities of Member States to require an institution to maintain “detailed” records of its financial contracts as part of recovery planning[2], resolution planning[3] and pursuant to powers to temporarily suspend termination rights[4].  “Financial Contracts”[5] include:

(a) securities contracts;

(b) commodities contracts;

(c) futures and forwards contracts;

(d) swap agreements;

(e) inter-bank borrowing agreements with a term of three months or less; and

(f) master agreements for any of the agreement types referred to in (a) to (e) above.

In the UK, The Bank Recovery and Resolution (No. 2) Order 2014 was published on 19 December 2014.  It largely comes into force on 10 January 2015 and gives the Bank of England the power[6], in relation to any “relevant person”[7], to:

(a) require records of financial contracts to be maintained;

(b) specify the details or kinds of detail which are to be recorded;

(c) require records of financial contracts to be produced at the request of the Bank;

(d) specify a time-limit within which a relevant person is to be capable of producing records; and

(e) specify different time-limits for different kinds of financial contract.

 The Meaning of “Detailed”

The BRRD requires the European Banking Authority to submit Regulatory Technical Standards to the EU Commission by 3 July 2015, specifying the minimum set of information on financial contracts that should be contained within “detailed records”[8].  In the meantime, we are left to make an educated guess at the meaning of the term “detailed”.  The starting assumption must be that the mere fact of the inclusion of the word “detailed” means that a simple repository of documents, even one which facilitates the ability to search, will not suffice.  Beyond this, a pointer as to the meaning of “detailed” can be found in Section B of the Annex to the BRRD.  This specifies the information that resolution authorities may request from institutions for the purposes of resolution planning, including all agreements:

  • entered into by a group with third parties the termination of which may be triggered by a decision of the authorities to apply a resolution tool; and
  • where the consequences of termination may affect the application of a resolution tool[9].

The power to transfer, modify or cancel contractual arrangements entered into by a firm under resolution form the essence of the ‘resolution tools’[10] under the BRRD.  As such, it seems reasonable to conclude that contractual termination rights, together with other provisions which might interfere with the ability of a resolution authority to value, transfer, net or set-off a derivatives transaction will be of most concern to resolution authorities and therefore most likely to form part of the “detailed” records requirement.  The list of clauses may be long, but would most likely include:

• Events of default

• Other termination rights

• Rehypothecation rights

• Ratings downgrade triggers

• Governing law

• (Non) Assignment

• Guarantors

• “Material adverse change”

• Cross-default

• Set-off and netting

• Credit support arrangements

 

Rising to the Data Challenge

Irrespective of the final regulatory requirements, understanding the content of portfolios of derivatives documentation is already a key risk management, competitive advantage and audit requirement for a number of firms.  Data is fast becoming the new competitive frontier.  The ability to access, validate and assimilate legal and commercial data, to combine it with other data sources, analyse results and rapidly form and apply conclusions is a factor which is already beginning to distinguish a select group of financial institutions from their peers.  At a time when transparency and reporting are keystones of the regulatory environment, not only are firms which have embraced a culture of data better able to achieve and demonstrate regulatory compliance, adapt to regulatory change and assess risk, but they are increasingly able to monetise this inherent advantage, turning data into dollars at the expense of competitors.

The significance of the regulatory requirement to provide “detailed” information on financial contracts should not be underestimated.  It represents the first occasion on which European regulators have been given specific powers to monitor the risks known to exist within large portfolios of derivative documentation.  Over the course of the next year, it will mean that many firms will be forced to commit significant resource to building or acquiring strategic solutions designed to unlock the information contained within large portfolios of derivative documentation.  Significant pressure will be brought to bear on firms with insufficient insight into these risks, so if you aren’t thinking about this challenge now, you will need to start thinking about it soon.  Whilst eminently do-able, successfully mining detailed information from portfolios of derivative documentation is by no means trivial.  On the plus-side, the firm-wide benefits from implementing a comprehensive solution are potentially huge.  Therefore, if the BRRD is the spark needed to ignite action in this area, it is to be welcomed with open arms.

 

[1] In its capacity as the UK’s resolution authority

[2] See Article 5(8) of the BRRD

[3] See Article 10(8) of the BRRD

[4] See Article 71(7) of the BRRD

[5] See Article 2(1)(100) of the BRRD

[6] See Article 58 (Records of financial contracts)

[7] Being (a) an institution authorised by the PRA or FCA, (b) an undertaking set up in the United Kingdom which is a subsidiary of an institution authorised by the PRA or FCA or in another EEA State, or (c) the EEA parent undertaking.

[8] See Article 71(8)

[9] See Paragraph (19)

[10] “Sale of Business”, “Bridge Institution”, “Asset Separation”, “Bail-in”

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