The European Securities and Markets Authority (ESMA) has published a discussion paper in order that industry participants can submit their queries and input with regard to the calculation of counterparty risk by undertakings for collective investment in transferable securities (UCITS) for OTC financial derivative transactions subject to clearing obligations.
ESMA is currently in the process of implementing the MiFID II rulings, part of which contain stringent trade reporting regulations which will require all trades to be processed via a central counterparty in both retail and institutional business.
The reason behind the publication of this particular discussion paper is that according to directive 2009/65/EC (the UCITS directive), UCITS can be invested in both exchange-traded derivatives and in OTC transactions.
Only investments in OTC derivatives transactions are subject to counterparty risk exposure limits in the UCITS directive. The guidelines on risk management and calculation of global exposure to counterparty risk for UCITS recommend that initial margin posted to and variation margin receivable from a broker relating to exchange-traded derivatives which are not protected by client money rules or other similar arrangements should also be taken into account for the calculation of counterparty risk.
Under the European Market Infrastructure Regulation (EMIR), certain OTC derivative transactions will become subject to clearing obligations, with FX being one that is currently being considered for this classification.
As a result, ESMA is seeking stakeholders’ views on how the limits on counterparty risk in OTC derivatives transactions that are centrally cleared should be calculated by UCITS and whether the same rules for both OTC and exchange-traded transactions should be applied by UCITS.
In an omnibus client segregation account, such as those used by white label partners of brokerages, the obligation for the clearing member and the central counterparty (CCP) is only to distinguish the assets and positions of the CM from the assets and positions held for the account of the clients of the clearing member. This means that the CM is allowed to post to the CCP only the net amount of collateral necessary to clear the OTC transactions of its clients. There is no individual segregation of the collateral at the CCP level and no requirement to collect the margins from clients on a gross basis. ESMA seeks to discuss and address concerns that arise from the difference between a non-EU central counterparty and an EU central counterparty relating to this aspect.
On this basis, ESMA considers it fair to conclude that omnibus accounts for UCITS offer less protection than individual client segregation when the clearing member defaults, a matter of interest for many brokers and white label partners depending on how their businesses are established. For example, white label partners often maintain an omnibus account which contains aggregated client funds, whereas partners of banks often maintain client-specific holding accounts.
ESMA has set a deadline of October 22, 2014 for response to the 18 questions that are set out in the consultation paper, which can be read and downloaded by clicking here.