Abdulla Pathan

Prepared with reference regulatory implementation Technical Standard published at EU Regulations related to EMIR/ESMA

Facts Lehman Default in 2008 Financial crisis Bear Stearns near collapse situation

Challenges lack of counterparty risk management a lack of transparency within the over the counter (OTC)

derivatives market

Resolution at G20“All standardised OTC derivative contracts should be

traded on exchanges or electronic trading platforms, where appropriate, and cleared through central counterparties by end-2012 at the latest.

OTC derivative contracts should be reported to trade repositories.

Non-centrally cleared contracts should be subject to higher capital requirements”

EMIR targeted for OTC Derivatives, Central counterparties ( CCPs) and Trade repositories ( TRs)

EMIR officiated on 4th July 2012 and enforced from 16 Aug 2012

ESMA published EU adopted Technical Standard on 19th Dec’2012

EMIR made mandatory from 15th Mar 2013 onwards

EMIR is designed to reduce the counterparty risk of OTC derivative Markets and increase transparency within the markets

EMIR Obligations Clearing - standardized derivative contracts should be cleared

through central counterparties in order to reduce the risk in the financial system

Margin & Capital/Risk mitigation - clearing counterparty shall have permanent, available and separate initial and variation margins in the form of highly liquid collateral

Reporting - all OTC derivative contracts should be reported to trade repositories

EMIR will enable Reporting to trade repositories

Clearing Obligations

Risk mitigation for uncleared trades

requirements for central counterparties (CCPs) and trade repositories (TRs)

EMIR applies to EU Firms trading with non-EU Firms

MIFID-II/MIFIR and CRD-IV will deliver more regulation for derivatives in the near future.

Entities EMIR Obligations

1. Financial Counterparties 2. Non-financial counterparties above the clearing threshold

Clearing ObligationsRisk Mitigation TechniquesReporting Obligations

Non-financial counterparties below the clearing threshold

Reporting ObligationsRisk Mitigation Techniques ( Timely

Confirmation, Portfolio reconciliation and compression, dispute resolution)

CCPs Application of organizationalConduct of business Prudential requirements

Trade Repositories 1. Reporting2. Duty to make certain data available to the public and relevant authorities

OTC derivatives Clearing and Risk Mitigation Techniques

All Derivatives Reporting Obligations

All Financial instruments CCP Obligations

Institutions needs to comply EMIR

◦ Financial Counterparties such as Banks, insurers, asset managers

◦ Non – Financial Counterparties

Exemption

◦ Pension Funds ( 3 years grace period)

◦ Intra group transactions

The counterparty should be a clearing member, a client of a clearing member (direct client) or a client of a client by having agreed indirect clearing arrangements.

It will depend on the best compromise between protection (full omnibus-account model/individual segregation/LSOC (“legally segregated, operationally commingled)

Model/future-style elementary clearing model) and operational efficiency.

OTC derivatives contracts that ESMA has determined subject to a mandatory clearing obligation must be cleared by CCP

A Clearing obligation will be applicable to contracts between any combinations of Financial counterparties and NFCs that are above the clearing threshold

Mandatory clearing obligations will apply to trade between such firms where:◦ One or more of the counterparties is in the EU

◦ In Limited circumstances, neither in the EU

Segregation Models

Pros Cons

Individual Client Segregation

•Highest level of protection•Facilitates Porting•Return of assets guaranteed

•Expensive•Loss of netting benefit

LSOC •High level of protection•Easier to administer

•Return of assets not guaranteed•Porting more difficult

Omnibus Client Segregation

•Cheaper alternative•Easier to administer

•Lower level of protection•Porting more difficult

€1bn in gross notional value for OTC credit and equity derivatives (individual thresholds)

€3bn in gross notional value for interest rate and FX (individual thresholds)

€3bn in gross notional value for commodities and others (combined threshold)

The clearing obligation applies to all OTC derivative contracts once one of the thresholds is reached

Transactions designed to reduce risks to commercial activity or treasury financing activity do not count towards the clearing threshold

When calculating its positions, a NFC must include all contracts entered into by all non financial entities within its group

ESMA ( European Securities and Markets Authority)

ESAM assess clearing obligation for OTC◦ Top-down approach ( ESMA to Local Market)

◦ Bottom-Up approach ( Local Market to ESMA)

Clearing Criteria◦ Degree of standardization

◦ Volume of trading and liquidity

◦ Availability of pricing information

The counterparty risk mitigation on cleared OTC derivative transactions forces counterparties to pay (from day one) initial and variation margins in highly liquid collateral (cash, gold, government bonds, etc.).

No cleared transactions will be subject to additional capital requirements.

Daily reporting to the competent authority will be required for all trades (OTC cleared, OTC not cleared but also exchanged ones) in order to identify potential pockets of systemic risk.

These new trade repositories (around 30 fields to be reported) not only concern trades openings but also modifications and terminations.

All counterparties to all derivatives contracts ( OTC and exchange-trade)◦ Report, post-trade, contract details to a registered trade repository

◦ Applies to all trades in the EEA

Information needs to be reported in brief◦ Parties to the contract/beneficiary

◦ Contract type

◦ Notional value

◦ Maturity

◦ Price

◦ Settlement date

Reporting Exposure◦ Only Financial and non-financial counterparties ( NFC) above the clearing

threshold are required to report exposures

◦ Mark to market or model valuations

◦ Collateral value and basis

Type of Exemption

Clearing obligations

Exchange of Collateral

ReportingObligation

Pension schemearrangement

Yes, until15/08/2015

No No

Intragrouptransaction

Yes, following a positive decision or a non-objection by the competent authority

Yes, following a positive decision or a non-objection by the competent authority

No

Challenges Key Actions

OTC derivatives valuation

1. How do I set up an effective valuation approach with the right information at the right time?

2. Can I outsource the valuations process?

3. How do I maintain good integration between the trade, pricing, valuation and collateral engines?

•Define your approach for the best OTC derivatives valuation (counter-check CCP prices,

using robust valuation process and independent sources)

•Organize daily reliable and verifiable monitoring of risk on the derivatives’ positions and their contribution to the overall risk profile of your portfolio•For complex instruments, possibly delegate to 3rd party middle office providers

Collateral and liquidity management

1. What are the expected additional funding needs?

2. Do I have the right tools to efficiently monitor and manage the collateral requirements?

•Assess the impact on your products and portfolio (cleared versus not cleared)

•Implement a portfolio reconciliation process•Adapt collateral management infrastructure and organization (e.g. increase STP level)

•Assess your additional daily funding needs (capital and margin)

•Choose a set-up with fewer clearers than executing brokers so as to maximize the netting effect

Challenges Key Actions

Business Model

1. Which part of my business could I outsource?

2. How do I select the right clearing member and/or CCP?

3. What do I have to do to become a clearing member?

4. How do I need to organize my accounts?

•Understand the regulations and the global value chain issues•Sign a new set of documentation for cleared OTCs with a clearing broker•Sign a collateral agreement•Define strategic options:

•Select your service provider model (CCPs

or clearing members),

•Define your counterparty risk level with your providers (accounts segregation &

protection level, operational efficiency, etc.)

•Seamless integration between trade, post trade and collateral activities•Evaluate whether you have the skills/mass to perform collateral management in-house or through outsourcing

Challenges Key Actions

Reporting

1. What will the impact be on my database?

2. Do I have all the information available in my system?

3. Can I outsource this business and to whom?

Update your processes and IT applications in order to:•Identify and provide required information•Identify transactions to report•Build and send your daily reporting file

Technical standards yet to be finalised:

◦ Arrangements for the establishment and functioning of CCP colleges (ESMA)

◦ Risk mitigation techniques for OTC derivatives that are not centrally cleared (joint ESA’s)

◦ Contracts that are considered to have a direct substantial and foreseeable effect in the Union or to prevent the evasion of EMIR (ESMA)

The EU Commission will set a new deadline for delivery of ii. and iii.