There has been a long-standing concern that banks are not fully complying with obligations to revise and refresh their netting opinions. Credit institutions are fully incentivised to comply with these requirements by the significant capital “savings” if netting is applicable. However, the same obligations apply to the buy side- at least those entities who are in scope of margin requirements. The requirement is explicit in Commission Delegated Regulation (EU) 2016/2251
General Requirements Article 2 (3) and (4).
3. Where counterparties enter into a netting or an exchange of collateral agreement, they shall perform an independent legal review of the enforceability of those agreements. That review may be conducted by an internal independent unit or by an independent third party.
The requirement to perform the review referred to in the first subparagraph shall be considered to be satisfied in relation to the netting agreement where that agreement is recognised in accordance with Article 296 of Regulation (EU) No 575/2013.
4.Counterparties shall establish policies to assess on a continuous basis the enforceability of the netting and the exchange of collateral agreements that they enter into.
The legislation has been transposed in its entirety to post-Brexit UK EMIR. Obviously this only applies to Counterparties, but in a bilateral transaction with two in-scope parties, the distinction serves to place the onus on you.
It has come to our attention that even if the sell side may be insufficiently-compliant, it is likely that a significant proportion of the sell side may be entirely non-compliant with this requirement. The obligation came in with the 1 September 2017 deadline and full compliance would require a robust process to:
- Verify the Counterparty’s legal location
- Identify the legal opinion specific to the counterparty’s jurisdiction and the legal agreement type;
- Check whether you already rely on a current legal opinion. This may be direct or via an industry association;
- Review the netting opinion with specific regard to the counterpart and applicable trading agreements
- Document all of the above to provide a full compliance audit trail
- Rinse and repeat. The Regulations specify a “continuous basis”. In reality, netting opinions are revised (repeated) annually.
The buy side has no “carrot” in CRR/CRE terms to comply and there has been nothing in the way of “stick” enforcement to concentrate minds. It is understandable that the industry-wide rush to comply with VM may have precluded instilling this ongoing obligation into a BAU process. However, we are some years hence and this specifically benign regulatory environment is unlikely to continue.
There are a range of netting opinion databases that will assist with this task. As an alternative to these somewhat pricey solutions, DRS has a team of opinion experts who perform this service for a wide range of clients at a highly competitive cost. In addition, our software product- Ark 51- can rapidly ingest and store any and all opinions together with the relevant review. Should the Regulator come knocking at the door, the ability to demonstrate in-house mastery of these, sometimes unwieldy, documents will prove invaluable.Contact Us