|Client segregation and portability under EMIR|
Client segregation and business models - any links?
Voluntary clearing notwithstanding, the increasing scope of the clearing obligation will more and more become the regulatory driver forcing firms to systemically rethink their market access strategies.
In this context it is useful to remind, counterparties may meet the clearing obligation imposed by EMIR as a direct clearing member, client of a clearing member or indirectly through a client of a clearing member.
The side effect of EMIR provisions is derivatives market participants are compelled to precisely identify their strategic needs as regards access to the central counterparties (CCPs).
When it comes to the latter issue the entities covered will have to choose first between CCPs or clearing members/clients as their service provider model.
To cope with this task the identification of the accepted counterparty risk level and the consequent assessments of available options regarding accounts' segregation (with the corresponding protection level), operational efficiency, etc. will be necessary.
The type of segregation regime "defines the conditions and the likelihood of transfer or liquidation, and more generally the level of protection for the clients and where relevant indirect clients. The main aspects of such protection are the posting of surplus collateral directly with the CCP, the portability and the direct return of assets" (ESMA's EMIR Review Report of 13 August 2015 - Review on the segregation and portability requirements (2015/1253)).
Types of client segregation under EMIR
EMIR does not allow the use of unsegregated accounts. Article 39(2) and 39(3) of EMIR provide that CCPs must offer both 'individual client segregation' and 'omnibus client segregation' (these terms being defined in Articles 39(2) and 39(3) of EMIR).
The guidance from the European Securities and Markets Authority (ESMA) underlines that while CCPs might offer other levels of protection in addition to individual client segregation and omnibus client segregation (e.g. an omnibus gross margin client model), omnibus client segregation is the minimum level of client protection that can be used under EMIR.
ESMA's EMIR Q&As include, moreover, a clearance on whether CCPs are required to provide segregated accounts for indirect clients (i.e. clients of the clients of the clearing members) - the regulators' stance is the CCP may, at the request of a clearing member, set up individually segregated accounts in which the positions and assets of indirect clients of a client may be recorded, but there is no obligation to do so.
It should be noted, however, as explained by the ESMA Q&As updated on 11 February 2014 (ESMA/2014/164), the provisions of Article 4 of EMIR and Article 2 of Commission Delegated Regulation (EU) No 149/2013 on indirect clearing apply only to OTC derivatives and not to all products (this is on account of they are lodged within Article 4 of EMIR and are said to be for the purpose of meeting the clearing obligation).
ESMA is considering the reasons for this lack of offer, including the commercial incentive and the existence of some legal impediment to provide indirect clearing services in accordance with the requirements of the RTS on OTC Derivatives."
It follows, Articles 2-5 of the Commission Delegated Regulation No 149/2013 on indirect clearing are lacking in practical significance at the moment. Moreover, the reasons for the absence of credible offers for indirect client clearing can also be easily identified.
Presumably, the problem is involved, among others, with serious legal risks threatening this kind of service, which are multiplied by jurisdictional specificities of the EU Member States insolvency laws (see below).
Omnibus client segregation
EMIR Article 39(2) wording requires for the omnibus client segregation that the CCP keeps separate records and accounts enabling the clearing member to distinguish the assets and positions of the clearing member from the assets and positions held for the account of its clients.
Simply put, in this option the client account is fully segregated from the house account, but the positions of the non-segregated clients are commingled. This is the minimum level of segregation required under EMIR.
The application of this model of client segregation requires the following agreements' structure:
- an agreement at a clearing member level with a client concerned,
- relevant framework agreement between the CCP and a clearing member.
The view has been presented ("Guideline for EMCF's Segregation & Portability Offering under EMIR"), this option is likely to be more economical both in terms of total margin called, settlement costs and number of collateral accounts required.
The account will have a single margin call and will therefore benefit from margin netting across all clients within the account.
The said argument is based on a market practice where the CCP generally call for margin on the basis of the aggregate positions in an omnibus client account (OSA), with the different trades being offset against each other.
However, one should be mindful of the distinction between between "gross omnibus" and "net omnibus" accounts (this differentiation - save for Commission Delegated Regulation (EU) 2017/2155 of 22 September 2017 amending Delegated Regulation (EU) No 149/2013 with regard to regulatory technical standards on indirect clearing arrangements - not reflected expressly in EMIR, in practice rather) where the former are designed as accounts for which the clearing member is required to post at least the sum of the margin amounts as calculated under the CCP methodology for each client portfolio separately.
Accordingly, only "net omnibus" accounts are accounts which allow the clearing member to post less than this aggregate amount.
Omnibus client segregation involves though, multiple legal risks, which may be to some extent mitigated by choosing another option i.e. individual client segregation.
Among those risks the key is that assets covering positions in an omnibus account are not exposed to losses only on positions recorded in any other account but within the account, one client's assets may be used to cover another client's positions. Hence the clients having omnibus client member account share their risks.
Another drawback of omnibus account represents the fact that excess collateral can be held at the clearing member level.
Moreover, omnibus possiblilities for netting are really interesting, but one should be mindful of the fact that positions can be netted only within an omnibus account and not across accounts.
Another shortcoming, as BBA, ISDA and FOA rightly assessed, is that for net omnibus account structures, the porting of the entire portfolio of assets and positions as a unit would be very difficult and rarely work in practice (BBA, ISDA and FOA response to HMT Segregation and Portability Consultation).
Individual client segregation
In this alternative EMIR Article 39(3) requires the CCP to keep separate records and accounts enabling the clearing member to distinguish the assets and positions held for the account of each client from those held for the account of each other client.
The main additional cost of this solution is that the individual client account (ISA) will be margined and settled separately from other accounts and will therefore not benefit from any cross client netting opportunities at margin or settlement level.
In practice, clients choosing the option of individual segregation are known by the CCP, while the omnibus clients may be not. An example is the European Commodity Clearing AG (ECC), which distinguishes the two above types of clients using the following criteria:
Also under Eurex Clearing arrangements for Individual Clearing Model clients are disclosed to the Eurex Clearing while under the UK CASS Compliant Omnibus Model are not, and apply for segregation with its clearing members.
The implementation of this model of client segregation requires a tripartite agreement between the CCP, clearing member and a non-clearing member.
Obligations of investment firms acting as general clearing members as regards disclosure of information about different levels of segregation
Investment firms acting as general clearing members are required to inform its prospective and existing clearing clients of the levels of protection and of the costs associated with the different levels of segregation offered (information must include a description of the main legal effects of the respective levels of segregation, including information on the insolvency law applicable in the relevant jurisdiction).
The legal base for the said requirements is Article 27(2) of the Commission Delegated Regulation (EU) 2017/589 of 19 July 2016 supplementing Directive 2014/65/EU of the European Parliament and of the Council with regard to regulatory technical standards specifying the organisational requirements of investment firms engaged in algorithmic trading.
Porting definition pursuant to EMIR
Porting under EMIR rules can be defined as the transferring of client positions and assets on the default of a clearing member to another clearing member designated by the client, the CCP must commit to on the client's request and without the consent of the defaulting clearing member.
This definition applies equally to omnibus and individually segregated accounts, with the distinction that in the case of omnibus client segregation the back-up clearing member must be designated by all clients.
The important reservation is the new clearing member is only required to accept the positions and assets if it has previously committed to do so.
The clients' request constitutes the sine qua non precondition for trigering procedures for porting as required under EMIR. Practically, the said request may be also effected by the trustee on behalf of all clients in an omnibus account.
Other preconditions for porting of positions and collateral held under individual or omnibus client segregation include:
1. The existence of alternative clearing arrangements for the client(s) with a back up clearing participant as required under the clearing rules;
2. The acceptance of the back-up clearing participant of all positions (the CCP may require such acceptance to be unconditional).
In all cases there is a need to have a back-up clearing broker that has agreed to accept the CCP transactions.
Theoretically, it would appear sensible to appoint a back-up clearing broker upfront as part of clearing arrangements but, as was observed by the industry, the back-up clearing broker is unlikely to be able to confirm that it is willing to accept the CCP transactions until the default occurs.
One should be also mindful of the fact that the back-up clearing broker may also have conditions that client must meet.
ESMA's Final Report of 14 November 2016 on the clearing obligation for financial counterparties with a limited volume of activity (ESMA/2016/1565, p. 9) observes in this regard:
"However, finding a back-up clearing member also proves to be challenging for the same reasons as the ones developed above for the main clearing member. Furthermore, clearing members are reported to be unwilling to act as pure backup clearing members, as this results in negative regulatory capital implications without any corresponding revenue. The preferred model is to have two active clearing members, each acting as backup of the other. Hence there is a plea for changes to the regulatory capital rules to be more supportive of "cold standby" backup clearing members unless and until positions are ported to them at a later stage."
In practice, the CCP rules may involve further operational safeguards enabling the CCP to retain legal safety of the whole process and mitigate potential legal risks. Among these CCP-specific issues are:
1. legal opinion on file on the on-going validity of authority to port granted by the defaulting clearing participant and the (non) applicability of anti-deprivation and/or voidance rules,
2. the written consent of the insolvency practitioner appointed for the defaulting clearing participant.
Sometimes CCP may impose additional requirements involving the satisfactory certainty that all pending settlements with the defaulting clearing participant will be cancelled, and that new equivalent instructions with the back up clearing participant will settle with good value (like the above EMCF rules).
Under LCH.Clearnet rulebook should a clearing member default, LCH.Clearnet declares it will work with clients to transfer positions and assets to an alternative clearing member, however, achieving a transfer is not guaranteed.
For LCH.Clearnet optimum conditions to achieve client porting include:
- the client being known to LCH.Clearnet and fully identified (i.e. not in an anonymous account),
- the client nominating an alternative clearing member within the time specified by LCH.Clearnet,
When it comes to the practical functioning of its porting mechanisms LCH.Clearnet refers to the MF Global case of November 2011, where, as the LCH.Clearnet declares, over 300 client positions were transferred to the clearing member of clients' choice.
Porting scope - back-to-back client trades excluded
Articles 48(5) and 48(6) of EMIR which deal with porting require the CCP to "contractually commit" to trigger a transfer to the non-defaulting clearing member where the clients of the defaulting clearing member request the transfer and have in place a contractual arrangement with the non-defaulting clearing member which commits him to accept a transfer.
Articles 48(5) and 48(6) of EMIR refer back to assets and positions held in accounts in accordance with Articles 39(2) and 39(3), which are accounts at the CCP, hence the above transfer can only affect the assets and positions held at the CCP.
Consequently, the basic provisions of EMIR only envisage porting of the margin and positions held in accounts at the CCP. They do not provide for the transfer of any margin (or back-to-back client trades) held by the defaulting clearing member for its underlying clients. The said interpretation is shared by BBA, ISDA and FOA (see the above-mentioned BBA, ISDA and FOA response to HMT Segregation and Portability Consultation).
Therefore, assets provided by the client to the clearing member as margin are at the so-called "transit risk" prior to transferring such assets to the CCP.
The risk for the client consists in the danger to loose assets provided by the client to the clearing member on account of the CCP margin if the clearing member was to default prior to providing such client assets to the CCP, this is since the assets that were intended to be recorded in the client account at the CCP will not benefit from EMIR protections before reaching CCP.
The issue arises whether such risk may be avoided. Generally the said risk originates in the "principal-to principal" clearing model. However, if margin is called by the CCP before clearing member is able to acquire relevant funds from its clients and, in effect, clearing member uses its own funds to satisfy the CCP margin call, the client is obviously protected.
In such situation clearing member is forced to recover such amounts from its clients only later - which results in clearing member exposition to its clients. The opposite arrangement will, however, be more common in practice.
Interpretational issues with respect to "assets"
The term: "assets" contained in Article 39(10) of EMIR raised some ambiguities in the practical application.
It is argued (ESMA's EMIR Review Report of 13 August 2015 - Review on the segregation and portability requirements (2015/1253)), Article 39(10) of EMIR lacks details as to the nature of records that should be implemented by the CCP and clearing members.
There is also the issue whether these records should only be reflecting the nominal value of the "asset" when deposited or the precise description and characteristics of such assets.
Moreover, the reference to assets "held to cover positions" could lead to the exclusion of "buffers" left by clients to clearing members and which can fulfil several purposes and cover different type of activities.
As such, until they are allocated, the assets do not cover specific positions and would thus not benefit from the protection foreseen in Article 39 and 48 of EMIR.
It was also unclear whether variation margin fell under the definition of assets.
EMIR porting requirements vs. insolvency law
Although EMIR, which took the form of the EU regulation, is directly applicable in all EU Member States, there appears to be a need for specific EMIR porting requirements' recognition under national laws on the insolvency of a clearing member.
There are concerns that relying solely on the EMIR provisions is not sufficient to provide explicit protection from national insolvency law for certain transfers. The above BBA, ISDA and FOA response to HMT Segregation and Portability Consultation made the two important general, practical observations:
1) that the UK and European clearing houses and clearing members generally apply the principal-to-principal model for clearing (let's add that under the said approach the clearing rules do not create a contractual relationship between the CCP and the clients of the clearing member), and
2) where the defaulting clearing member is acting as principal the general market practice is that clearing members would not net or offset positions across clients, so there would always be a one-to-one correspondence between a client trade and the position at the CCP (the one-to-one position may, however, not extend to margin, which may be calculated by the CCP on the basis of the aggregate positions in an omnibus account, i.e. the CCP margin call toward the clearing member could be reduced due to offsetting trades between different clients of the clearing member).
The above factual circumstances can be contrasted with legal conclusions that:
1) EMIR does not provide for the porting of the underlying client back-to-back trades with clearing members (client trades), which arise where the clearing member is acting as principal, and the associated margin held by the clearing member,
2) there is a need for checking whether the principal-to-principal relationships and the porting of the connected underlying client trades (the 'client trade') should not also be recognised under Member State's national insolvency law.
There are also concerns whether the provisions in EMIR would, without more, override provisions of national insolvency law in relation to the transfer of assets and positions which might legally belong to a defaulting clearing member (DCM).
Where the DCM deals as principal with the CCP then margin and positions at the CCP, even if relating to client trades, will technically be the property of the DCM. A transfer of those positions and assets by a provision of a private law contract (such as the membership rules of the CCP) could constitute a void disposition under Member State's national insolvency law.
Hence, the optimal solution would be to provide through the relevant amendments to the national law a mechanism to transfer both assets and positions at the CCP, as well as corresponding margin and client trades with the DCM, in a way which should protect those transfers under Member States' national insolvency law.
Considering, however, the territorially-restricted character of each of Member States' national laws, the relevant protections included therein may only apply in relation to a DCM which is subject to insolvency law of that particular national law. The same will apply also to the CCP.
The above BOA, ISDA and FOA response make the point that the position is less clear where either the clearing member or the CCP is located in another jurisdiction than the one the clearing member client is subject to.
Referring to the relevant EMIR-implementation legislative initiative on the ground of the UK law, the above-mentioned analysis highlighted that it would appear that transfers of assets and positions belonging to a non-UK DCM would not be protected if the insolvency law of the clearing member's jurisdiction of incorporation or establishment did not provide an equivalent to the UK law level of protection from the applicable insolvency law.
Continuing the example of the UK insolvency law, above organisations also observed that transfers by the CCP pursuant to its default rules might be subject to challenge under the insolvency law applicable to the non-UK clearing member.
The method for introducing the comprehensive and complementary legislative EMIR insolvency solutions at the level of each Member State (taken separately) appears burdensome, thus in the joint opinion of the above organistations the optimum choice is the requirement imposed at the EU level on member states to protect the porting of assets and positions (both at the CCP level and the level of the clearing member) from the effects of member state insolvency law.
Another area of potential discrepancy between EMIR and insolvency laws are circumstances where individually segregated client collateral is held in the books of CCP and EMIR requires that collateral balances owed by CCP after completion of default procedures, i.e. unused collateral, must be readily returned to the client if known to CCP.
Legal risk involved is that the national insolvency law may allow the payment of such residual collateral provided, the insolvency practitioner of the defaulting clearing participant expressed its consent.
The potential mitigant for such risk may be a pledge agreement with the clearing participant as pledgor and the client as pledgee.
The aforementioned ESMA's Report of 13 August 2015 contains the following ESMA's recommendations for future amendments of EMIR (p. 10): "the provisions of Article 39 of EMIR should be specific on the effects for the different accounts following the clearing member default, i.e. if assets shall be ported or proceeds directly returned to clients, the Article should specify that this is the case and that the insolvency administrator of a clearing member shall not prevent this from happening. This would clearly state the supremacy of an EU Regulation over national insolvency laws, rather than a simple reference in a recital."
See below an excerpt from the aforementioned ESMA Report (p. 12):
The European Commission Proposal of May 2017 for a Regulation of the European Parliament and of the Council amending Regulation (EU) No 648/2012 as regards the clearing obligation, the suspension of the clearing obligation, the reporting requirements, the risk-mitigation techniques for OTC derivatives contracts not cleared by a central counterparty, the registration and supervision of trade repositories and the requirements for trade repositories (COM(2017)208, p. 15) inserted a draft paragraph to EMIR Article 39 to clarify that assets covering the positions recorded in an account are not part of the insolvency estate of the CCP or clearing member that keeps separate records and accounts.
This provision is intended to offer certitude to:
- those who provide clearing services or offer their clients the possibility to provide such services that they can fulfil their commitments with regard to the EMIR default management procedures as well as to incentivise them to provide access to central clearing of OTC derivatives contracts as a service;
- clients and indirect clients that in the case of default of a clearing member or a client providing clearing services, their assets are protected and can, thus, be ported to other clearing members or clients that provide indirect clearing services.
However, FIA Response of 18 July 2017 to the European Commission EMIR Review Proposal – Part 1 (REFIT Proposals) recommends that:
- the above Proposal for the draft Regulation be extended to address indirect clearing arrangements: direct clients providing indirect clearing services should also be required to hold client collateral on a bankruptcy remote basis and the Proposal should clarify how clearing members should treat the assets and positions of their clients in the event of a client default (when their direct clients are providing clearing services to indirect clients);
- the said Proposal should not cover the situation of a CCP default (since CCP resilience, recovery and resolution should be solely addressed in a separate EU regulation).
FIA underlines that there are overlaps with the provisions of the Financial Collateral Directive and an interface with the the Settlement Finality Directive and legal effectiveness of the insolvency remoteness of the assets and positions of clients or indirect clients depends on the arrangements between the parties, the jurisdiction of the parties, the type of asset and the lex situs of the assets.
Also ISDA encourages the European Commission to reconsider the proposed scope and drafting approach so that clearing members are also protected in the event of their client's default (when such clients are providing clearing services to their clients).
According to the ISDA, Article 39 EMIR should cover default of clearing members and their clients, while it should not cover CCP default as there is separate European legislation governing CCP resilience, recovery and resolution and any legal consequences of CCP default should be dealt with in that legislation (International Swaps and Derivatives Association (ISDA) comments on the ‘EMIR Refit’ proposal, 18 July 2017).
Final Regulation (EU) 2019/834 of the European Parliament and of the Council of 20 May 2019 amending Regulation (EU) No 648/2012 as regards the clearing obligation, the suspension of the clearing obligation, the reporting requirements, the risk-mitigation techniques for OTC derivative contracts not cleared by a central counterparty, the registration and supervision of trade repositories and the requirements for trade repositories (EMIR REFIT) adopted in this regard the following wording:
‘11. Member States' national insolvency laws shall not prevent a CCP from acting in accordance with Article 48(5), (6) and (7) with regard to the assets and positions recorded in accounts as referred to in paragraphs 2 to 5 of this Article.’
Territorial scope of requirements on clearing members pursuant to EMIR
The requirements on clearing members that are laid down in EMIR (e.g. those in Articles 38 and 39 of EMIR) apply to clearing members of all CCPs established in the European Union.
ESMA's Q&As of 11 November 2013 clarify that the non-EU clearing members of EU CCPs providing services to EU clients are also subject to the segregation requirements in Article 39.
Hence, references to clearing members in Article 39 are not limited to EU clearing members, so all clearing members of EU CCPs are required to comply. CCPs are expected to require all clearing members to comply with the relevant EMIR provisions through their rules.
On the other hand, EU clearing members of non-EU CCPs are not required to comply with Article 39 when offering client clearing on non-EU CCPs.
However, EU clearing members will only be allowed to be a clearing members of a non-EU CCP which has been recognised as meeting equivalent requirements to EMIR under the process set out in Article 25 of EMIR. This will include an assessment of the CCP's segregation arrangements.
The ESMA's Q&As (version of 10 July 2014) have added that, similarly, the references to clients in Article 39 are not limited to EU clients.
Porting agreements pursuant to EMIR
As cited above, Article 48(5) and 48(6) of EMIR require the CCP to "contractually commit" to trigger a transfer to the non-defaulting clearing member where the clients of the defaulting clearing member request the transfer and have in place a contractual arrangement with the non-defaulting clearing member which commits him to accept a transfer.
To account for the above EMIR requirement it may be useful to differentiate the following kinds of agreements that may be needed to arrange for the relevant transfers and settlements:
1. Firstly, the wording of EMIR expressly makes a referrence to the agreement between clients of the defaulting clearing member on the one part and the non-defaulting clearing member on the other, the object of the said agreement being the commitment of the non-defaulting clearing member to accept a transfer of the assets and positions held by the defaulting clearing member for the account of its clients.
A practical remark has been made that it would make sense for the defaulting clearing member to also be a party to these arrangements.
2. Secondly, "contractual commitment" required of the CCP by Articles 48(5) and 48(6) of EMIR will most likely be implemented in the CCP internal regulations and automatically, in the clearing member admission legal documentation, however in relation to the transfer of client positions and associated margin registered with the CCP this may not matter as the provisions of EMIR are directly applicable.
Taking practical examples into account, under the European Commodity Clearing AG (ECC) rules legal basis for individual segregation is the collateral agreement for the passing through of collateral (NCM07) which has to be signed by the non-clearing member (NCM) requesting segregation, his clearing member and ECC.
Additionally a Close-out Netting Agreement has to be signed between the clearing member and the segregated non-clearing member as a precondition for the segregation.
As all non-clearing members already have separate position accounts, no further technical setup is required for individual segregation of positions, as a segregated non-clearing member position account is technically identical to a regular account for this type of membership.
3. The third situation involves contractual arrangements for the potential transfer of the client trades between the defaulting clearing member and its clients and any associated excess margin held by the defaulting clearing member.
As mentioned above, EMIR does not provide for such transfers, however the EU Member State's national law may additionally protect the legitimate interests of clearing member's clients and expressly require the default rules of a CCP to include provisions that would enable it to require the transfer of client trades and associated excess gross margin from a defaulting clearing member to a non-defaulting clearing member where the corresponding client positions and margin at the CCP are being transferred and, in respect of the excess gross margin, the parties have agreed that this should also be ported.
This case in turn in practice will likely require multilateral agreements between the CCP, defaulting clearing member, non-defaulting clearing member and each of its clients to enable the novation of client positions and client trades, and the transfers of margin, from the defaulting clearing member to the non-defaulting clearing member.
Technically, if porting is achieved, client transactions with the defaulting clearing member will in most cases terminate in accordance with client clearing agreement and the client will have to put in place with back-up clearing broker new client transactions.
In Q&As as updated on 20 March 2014 ESMA expressed its positive, under certain circumstances, opinion on the provision in the CCP rules and/or operating procedures under which the CCP can, if so requested by a clearing member, transfer the positions and assets held for the account of a defaulted client of that clearing member from the segregated account holding those positions and assets into the house account of the clearing member to facilitate the management of the client default by the clearing member.
ESMA has explained that it is the responsibility of the clearing member to inform the CCP of the account to which positions and assets held by the clearing member should be allocated.
The contractual arrangement between a clearing member and its client may provide for the positions and assets held for the account of the client to be transferred to the house or proprietary account of the clearing member in the event of a default of the client.
Accordingly, pursuant to ESMA, there should be no restriction on the ability of a CCP to transfer the positions and assets held for the account of a defaulted client into the house account of the clearing member on instruction of that clearing member, subject to that clearing member not being in default itself and in accordance with any applicable valuation and other rules and/or operating procedures of the CCP.
This existence of such a process should be clearly disclosed by CCPs and clearing members; for example, as required by Article 39(7) of EMIR and would need to be compatible with the applicable insolvency law.
Date of implementation of requirements for individual client segregation and portability
The requirements on clearing members for individual client segregation and portability that are established in EMIR (e.g. those in Articles 38 and 39 of EMIR) apply to clearing members of all CCPs established in the European Union. These obligations therefore come into force at and should be met by the time that the CCP is authorised under EMIR (see ESMA Q&As on EMIR (CCP Question 8(c) below).
Given the authorisation under EMIR Regulation of Nasdaq OMX Clearing AB by the Finansinspektionen in Sweden as the first EU-based CCP on 18 March 2014 the relevant requirements on clearing members of Nasdaq OMX (e.g. those in Articles 38 and 39 of EMIR) came into force on 18 March 2014.
It follows that the requirements will start its application with respect to clearing members of other clearing houses with further developments as regards the CCP registration process (the procedures are pending, other dates of CCP authorisation see here).
Main dilemma for clients - which type of account to choose
In summary, the main effects of segregation are:
a. Separate accounts
The assets and positions must be recorded in separate accounts:
- in the case of individual client account - for every client,
- in the case of omnibus client account - for clearing member house settlements and client trades.
b. Netting impossible
The netting of positions recorded on different accounts is prevented.
c. No exposition to losses in other accounts
The assets covering the positions recorded in an account are not exposed to losses connected to positions recorded in another account.
An example for practical application of those rules is given by the Eurex Clearing, which declares on its website that potential losses from a clearing member's default are covered by the existing Eurex Clearing lines of defense and segregated client collateral "will be completely ring-fenced and will not be set-off with losses of a clearing member or other clients".
In that regard regulatory guidance from ESMA explains, however, that the account at the CCP must identify the specific assets (e.g. the particular or equivalent securities) due to the account of the client and it is not sufficient that it identifies only the value due to that account, alternative approaches to segregation that identify only the value due to the accounts of the clients (while recording the assets provided for the account overall) may be offered only in addition.
The said EMIR rule has also one more interesting effect, namely where a clearing member desires to use its own assets (i.e. assets that were not posted by a client of the clearing member) to fulfil the margin requirements of the client account, then such assets could be recorded in a client account at a CCP, however in doing so the assets would be treated as assets held for the account of clients of the clearing member. This would mean that upon a default of the clearing member, the assets would be exposed to losses connected to the client account in which the assets were recorded and could no longer be used to meet any losses on the defaulted clearing member's house account(s). This interpretation has been acknowledged by ESMA in regulatory guidance.
d. Excess margin posted to the CCP
When a client opts for individual client segregation, any margin in excess of the client's requirement must also be posted to the CCP and distinguished from the margins of other clients or clearing members and must not be exposed to losses connected to positions recorded in another account.
Referring to Article 39(6) of EMIR (which states that when a client opts for individual segregation any margin in excess of the client's requirement shall be posted to the CCP) ESMA underlines, any excess collateral allocated to an individually segregated account must either be maintained at the CCP in accordance with article 39(6) or returned to the client.
In this context the two factual circumstances have been distinguished by the European financial regulator, which stressed that CCPs should offer clearing members the possibility of holding excess margin allocated to an individually segregated account at the CCP in that account (i.e. switching off auto repay), provided that the CCP can hold the currency in which the cash variation margin is denominated overnight in compliance with the CCP's investment policy.
In turn, when variation margins are denominated in currencies that the CCP cannot hold overnight (e.g. because it has no overnight investment facilities for such currencies - typically, currencies not accepted for initial margins), the CCP has no obligation to accommodate these currencies and the clearing member is required to return the collateral to the client, unless the latter, via a documented request, instructed the clearing member to hold the client's repaid variation margins in a non-clearing account meeting the relevant conditions.
Regulatory guidance from ESMA makes also clear that variation margin payments, representing amounts of margins called by the CCP are required to be recorded in separate records and accounts maintained for the individually segregated client at the CCP.
However, this requirement does not imply that payment instructions must be made for every individually segregated account separately. CCPs may therefore issue one payment instruction for multiple accounts at the same time, so long as they issue separate margin calls for each account (house, omnibus client, individually segregated client account) and correctly record these margin calls, and the payments which correspond to them, in the records of each account.
It is noteworthy that EMIR provisions on segregation and margin also call into question, because of how margin amounts are calculated and irrespective of legal challenges, the CCP interoperability arangements for cross-margining under which two (or potentially more) CCPs set margin requirements on the basis of the portfolio of positions that a clearing member holds across the two CCPs.
e. Ability to port the CCP transactions
The type of account and level of segregation have an impact on the ability to port CCP transactions and assets to a back-up clearing broker upon clearing member's default.
If client chooses an omnibus client account, in most cases, all clients who have CCP transactions and assets relating to them recorded in the same omnibus client account will have to agree to use the same back-up clearing broker, and the back-up clearing broker will have to agree to accept all of the CCP transactions and assets recorded in that omnibus client account.
Since, it would be rather difficult to achieve porting in relation to an omnibus client account.
If client arranges for an individual client account, it would make more sense because the client can appoint a back-up clearing broker with respect to just its CCP transactions and the related assets.
f. Close-out settlements
Given that the identity of the client is more likely to be known to the CCP in the case of individual client account, if the CCP terminates the CCP transactions and performs a close-out calculation in respect of them in accordance with the CCP rules, it is likely that the CCP will be able in the case of individual client account to pay any resulting positive difference directly to the client.
If the CCP does not know client identity and/or does not know how much of the amount relates to the client (what is more probable with respect to the omnibus client account), the CCP will pay to the defaulting clearing member (or its insolvency practitioner) for the account of its clients (however, practically, such sums are under serious risk to be entirely or partially lost for the client). So, this is an argument supporting the individual client account option.
g. Fees, charges and costs
Although having indisputable merits in terms of legal protection, individual client segregation is likely to be involved with additional CCP charges to cover the extra administration and monitoring required (such additional costs envisioned for instance by the EMCF). The use of different types of account may involve different costs or levels of collateral requirement, thus the lacking netting opportunities for the individually segregated client, both margin and settlement level, should also be weighed up.
In general terms, the clearing participant's decisions on the choice of the type of collateral and positions segregation need a risk-appetite's reflection and be based on individual assessments. It is likely, however, that the omnibus client segregation as the minimum level of segregation required (separate house and client position and collateral accounts) will in practice represent the standard CCP membership service while the individual segregation will pose a product tailored to specific needs of clients.
For omnibus clients segregation risks see also: Omnibus client account.
Legislative tendencies with respect to EMIR provisions on segregation and portability
ESMA EMIR Review Report - Review on the segregation and portability requirement (2015/1253, p.11) sets out the regulator's views with respect to what has to be done in order to improve current flaws of the regulatory framework.
ESMA Discussion Paper of 26 August 2015, Review of Article 26 of RTS No 153/2013 with respect to client accounts (ESMA/2015/1295) analyses the possibilities for greater security for clients in relation to porting, with a view to mitigating the risks of losses on the default of its clearing member.
According to the ESMA, it could be considered that each client must have an existing arrangement with a secondary clearing member whereby the latter irrevocably agreed that the client's assets and positions are ported to it from the client's primary clearing member in case of the latter's default, and that the CCP has all the operational arrangements in place to transfer the positions and the assets within a day.
The above considerations relate to OTC derivatives, where the respective requirements are set in the EMIR itself as well as in Commission Delegated Regulation No 149/2013 (EMIR RTS).
However, EMIR RTS currently in force serves as the baseline in relation to the framework for indirect clearing arrangements with regard to exchange-traded derivatives (ETDs), which are to be established under the empowerment of Article 30 of MiFIR.
In addition, the MiFIR empowerment specifies that consistency should be ensured between the requirements for indirect clearing arrangements with regard to exchange-traded derivatives and the requirements for indirect clearing arrangements with regard to OTC derivatives as per EMIR RTS.
To manage all respective interdependencies Consultation Paper Indirect clearing arrangements under EMIR and MiFIR of 5 November 2015 (ESMA/2015/1628) has been issued by ESMA.
Further, the Commission Delegated Regulation (EU) 2017/2155 of 22 September 2017 amending Delegated Regulation (EU) No 149/2013 with regard to regulatory technical standards on indirect clearing arrangements has been adopted.
EMIR, Articles 39, 48
Proposal for a Regulation of the European Parliament and of the Council amending Regulation (EU) No 648/2012 as regards the clearing obligation, the suspension of the clearing obligation, the reporting requirements, the risk-mitigation techniques for OTC derivatives contracts not cleared by a central counterparty, the registration and supervision of trade repositories and the requirements for trade repositories, COM(2017)208, May 2017, p. 15, 16
Commission Delegated Regulation (EU) 2017/589 of 19 July 2016 supplementing Directive 2014/65/EU of the European Parliament and of the Council with regard to regulatory technical standards specifying the organisational requirements of investment firms engaged in algorithmic trading, Article 27(2)
Commission Delegated Regulation (EU) No 149/2013 of 19 December 2012 supplementing Regulation (EU) No 648/2012 of the European Parliament and of the Council with regard to regulatory technical standards on indirect clearing arrangements, the clearing obligation, the public register, access to a trading venue, non-financial counterparties, and risk mitigation techniques for OTC derivatives contracts not cleared by a CCP, OJ L 52, 23.2.2013, p. 11
EMIR Article 39 disclosures
|Last Updated on Sunday, 15 March 2020 08:31|