Concentration limits on collateral pursuant to EMIR draft RTS
Sunday, 27 April 2014 09:12

 

Pursuant to the draft RTS, depending on the assets' class, the concentration limits on initial and variation margins range from 10 to 50%. Non-financials below a clearing threshold shouldn't bother.

 

EMIR requires financial counterparties to have risk management procedures in place that require the timely, accurate and appropriately segregated exchange of collateral with respect to OTC derivative contracts.

 

Non-financial counterparties must have similar procedures in place, if they are above the clearing threshold, thus those not required under EMIR to clear their OTC derivatives contracts are also exempted from the exchange of collateral.

 

Consultation Paper of 14 April 2014 "Draft regulatory technical standards on risk-mitigation techniques for OTC-derivative contracts not cleared by a CCP under Article 11(15) of Regulation (EU) No 648/2012" (JC/CP/2014/03) presents the preliminary thinking of European financial supervisory authorities on the collateral issue under EMIR.

 

In particular, to prevent the build-up of uncollateralised exposures within the system, the draft regulatory technical standards (RTS) require the daily exchange of variation margin between counterparties.

 

 

Eligible collateral for initial and variation margin

and its concentration limits

 

The following asset classes are purported according to RTS to be eligible as collateral for the purposes of Article 11(3) of Regulation (EU) No 648/2012 from which the counterparties can agree:

 

(a) cash in the form of money credited to an account in any currency, or similar claims for the repayment of money, such as money market deposits;

 

(b) gold in the form of allocated pure gold bullion of recognised good delivery (concentration limit 10%);

 

(c) debt securities issued by Member States' central governments and central banks (concentration limit 50%);

 

(d) debt securities issued by Member States' regional governments or local authorities according to Art. 115 (2) of Regulation (EU) No. 575/2013 (concentration limit 50%);

 

(e) debt securities issued by Member States' public sector entities according to Art. 116 (4) of Regulation (EU) No. 575/2013 (concentration limit 50%);

 

(f) debt securities issued by Member States' regional governments or local authorities not meeting the requirements of Art. 115 (2) of Regulation (EU) No. 575/2013 (concentration limit 10%);

 

(g) debt securities issued by Member States' public sector entities not meeting the requirements of Art. 116 (4) of Regulation (EU) No. 575/2013 (concentration limit 10%);

 

(h) debt securities issued by multilateral development banks listed in Art. 117 (2) of Regulation (EU) No. 575/2013;

 

(i) debt securities issued by the International Organisations listed in Art. 118 of Regulation (EU) No. 575/2013;

 

(j) debt Securities issued by non-Member States' governments and central banks (concentration limit 50%);

 

(k) debt Securities issued by non-Member States' regional governments or local authorities that meet the requirements of the first subparagraph of Art. 115 (2) of Regulation (EU) No. 575/2013 and non-Member States' public sector entities that meet the requirements of Art. 116 (4) of Regulation (EU) No. 575/2013 (concentration limit 50%);

 

(l) debt securities issued by non-Member States' regional governments, local authorities not meeting the requirements of the first subparagraph of Art. 115 (2) of Regulation (EU) No. 575/2013 or non-Member States' public sector entities not meeting the requirements of the first subparagraph of Art. 116 (4) of Regulation (EU) No. 575/2013 (concentration limit 10%);

 

(m) debt securities issued by credit institutions and investment firms including bonds referred to in Article 52(4) of Directive 2009/65/EC;

 

(n) corporate bonds (concentration limit 10%);

 

(o) the most senior tranche of a securitization that is not re-securitisation (concentration limit 10%);

 

(p) convertible bonds provided that they can be converted only into equities which are included in a main index as referred to in point (a) of Article 197 (8) of Regulation (EU) No 575/2013 (concentration limit 10%);

 

(q) equities included in a main index in accordance with Article 197(8)(a) of Regulation (EU) 575/2013 (concentration limit 10%);

 

(r) shares or units in UCITS, provided that the criteria in Article 5 LEC are met (concentration limit 10%).

 

Note that securities referred to in points (f), (g), from (k) to (r) above are eligible only if they fulfil the following criteria:

- are not issued by the posting counterparty;

- are not issued by entities which are part of the same group of the posting counterparty, as defined in Article 2(16) of Regulation 648/2012, or entities which have close links in accordance with Article 2(24) of Regulation (EU) No 648/2012.

- are not otherwise subject to significant wrong way risk.

 

Subject to the provisions of the RTS, both financial and non-financial counterparties above the clearing threshold, will also be required to exchange two-way initial margin to cover the potential future exposure resulting from a counterparty default. 

 

The provisions of the RTS on initial margin will apply to entities that have an OTC derivative exposure above a threshold of EUR 8 billion in gross notional outstanding.

 

RTS propose the introduction of concentration limits on the collateral collected from a counterparty.

 

As opposite to all other types of collateral, collateral posted in the form of cash has been addressed by the RTS preferentially, since it would not be subject to any concentration limits.

 

Imposing concentration limits on all other types of collateral is intended to help promote a diversified collateral pool, which will be less likely to face liquidation issues in the event of a counterparty default.

 

Among operational issues to be resolved yet is the introduction of proportionality thresholds, below which the concentration limits would not apply.

 

In the absence of such a threshold counterparties with limited margin requirements would need to diversify into smaller lots of many different issuers. This, as RTS acknowledge, can be operationally quite burdensome while the overall exposure may be of such a size that a single security can be liquidated without significant effects even in stressed market conditions.

 

Concentration limits indicated in the box refer to the sum of the values of relevant securities issued by a single issuer, by entities which are part of the same group as defined in Article 2(16) of Regulation 648/2012 or entities which have close links in accordance with Article 2 (24) of Regulation (EU) No 648/2012 and denote the maximum value of the collateral collected from that individual counterparty. 

 

In addition to the concentration limits indicated in the box RTS propose also that the sum of the values of the securities (o), (p), (q) [securitisation, convert. bonds and equities] and (r) [shares in UCITS], with (p) and (q) [convert. bonds and equities] limited to those issued by institutions as defined in Regulation (EU) No 575/2013, must not exceed 40% of the collateral collected from that individual counterparty.

 

 

 

 

 

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