CCPs’ EMIR preparation stalled by regulatory ambiguity

Clearing houses have blamed regulatory delays for the lack of progress on the development of solutions to ensure the protection of buy-side assets under new European OTC derivatives legislation.

Clearing houses have blamed regulatory delays for the lack of progress on the development of solutions to ensure the protection of buy-side assets under new European OTC derivatives legislation.

The acknowledgement follows concerns raised by UK buy-side trade body the Investment Management Association (IMA) in response to a consultation held by the European Securities and Markets Authority on detailed rules underpinning the European market infrastructure regulation (EMIR).

The IMA said it was worried at the lack of detail on how clearers would switch asset managers’ derivatives exposures to other entities in the event of a clearing member default. Under EMIR – Europe’s new framework for the OTC derivatives market – migrating positions would be the responsibility of central counterparties (CCPs) but the IMA has argued clearing houses may not have access to the precise underlying details required to carry this out.

“Those with the information about the buy-side’s complete exposures and assets are typically the clearing members, as opposed to the CCPs themselves,” Jane Lowe, director of markets at the IMA, told “Currently, the structure obscures the identity of the client, which makes it much more difficult for assets to be returned to the rightful owner in a default situation.”

Under EMIR, CCPs have to offer clients the ability to legally and operationally segregate collateral and positions in the event that a clearing member or the clearing house itself goes bankrupt.

Lowe added that the individual insolvency laws have caused further complications. Under UK rules, for instance, the ownership of positions and assets lies with clearing members, as well as with buy-side clients and CCPs, creating further problems in terms of determining exposures.

“While the buy-side want CCPs to work harder on providing protection for clients who want full segregation, they are hobbled by the fact that current UK legislation on insolvency makes it cumbersome, said Lowe. “EMIR is also neutral about how segregation of assets is to be achieved. While the regulation is clear on what protections are required, the steps that need to be taken to achieve this are more open.”

Reports from earlier this week suggest that the UK Treasury is looking at amending the Companies Act, which covers insolvency, in preparation for EMIR.

Ahead of the game 

But some CCPs are further ahead than others when it comes to presenting segregation options to the buy-side. Deutsche Börse-owned Eurex Clearing, Anglo-French clearer LCH.Clearnet, CME Clearing Europe, ICE Clear Europe and Nasdaq OMX Clearing, which will offer OTC clearing for Nordic swaps, are expected to compete for the lion’s share of OTC derivatives clearing. Eurex Clearing already has vast experience in clearing listed derivatives for its vertically integrated market, while LCH.Clearnet has thus far focused on cash equities and clearing of swaps for banks. US-based CME Clearing Europe and ICE Clear Europe are adapting their offerings to comply with European legislation.

“ICE Clear Europe is investing substantial time and resources in this area to comply with the rules as they become evident,” read a statement from ICE Clear Europe, which is owned by US futures market IntercontinentalExchange. “ICE is working to ensure that new solutions maximise the protection of buy-side assets, while minimising unintended consequences.“

Agreeing with Lowe’s assertion that EMIR currently only offers broad guidance on how CCPs should shape their individual segregation offerings, Xavier Hoche, COO of AXA Investment Managers trading and securities financing division, added that clearers priorities might lie elsewhere.

“It is understandable that asset segregation may not be the first focus for many CCPs because there are other aspects of EMIR that need to be tackled and are just as important,” said Hoche. “For instance, only one CCP – LCH.Clearnet – has started clearing the buy-side’s swaps trades in Europe for some time, so it is difficult to say whether they are all meeting the industry’s needs.”

As part of its preparation for EMIR, AXA IM is clearing a limited number of swaps trades for a small group of portfolios with LCH.Clearnet.

“We are establishing a proof of concept workflow on a limited scope of portfolios and instruments, from execution, to settlement, margin call payments, and valuation – with the aim of using this practical experience to form our approach for the future,” said Hoche. “Although EMIR is supposed to kick in at the start of 2013, we believe there will be some delays or at least a phased-in approach, so we are aiming to be fully prepared by Q2 2013.”

Wait and see 

Renaud Huck, head of UK institutional investor relations at Eurex Clearing, says complex scenarios currently agreed under bespoke bilateral agreements could make buy-side segregation difficult to achieve. Resolving such issues would be easier once the market becomes more accustomed to central clearing of swaps, he believed. 

Eurex Clearing offers a model that protects asset managers’ positions via a tripartite agreement it holds with the buy-side client and the clearing member. Industry observers point out that the complexities of UK law that have hampered the progress of some CCPs do not exist under Germany’s legal framework.

If a clearing member becomes insolvent, the tripartite agreement turns into a bilateral agreement between Eurex and the buy-side client, allowing the CCP to port positions and collateral to a new clearing member chosen by the asset manager.

Renaud Huck, Eurex“The recent MF Global saga showed that the market needs robust and efficient segregation arrangements,” said Huck. “We have spent a lot of time trying to determine the best model that protects against the default of the clearing member by holding the buy-side’s collateral in a separate custodian account managed by Clearstream.”

Clearstream is the international central securities depository owned by Deutsche Börse Group. MF Global, a US-based broker-dealer, was alleged to have deliberately used up to US$1.6 billion in client funds to help cover bad bets on European sovereign debt that led to US$3.6 billion in proprietary losses. More recently, another US futures broker, Peregrine Financial Group was accused of a similar breach.

Key elements of Eurex’s segregation offering are that positions are valued using mark-to-market as they are ported to a new clearing member and collateral is not liquidated.

“One of our key goals was to apply a ‘soft-touch’ approach to managing the buy-side assets in the event of market stress to help facilitate a smooth transition of its positions,” added Huck. “The global shift towards OTC clearing means a considerable amount of good quality collateral will be needed. In light of the estimations we felt it was unnecessary to liquidate collateral like some other clearers.”