ESMA
contemplates that in order to comply with the clearing obligation a
counterparty must become a clearing member, a client, or establish indirect
clearing arrangements. The draft does not provide details regarding indirect
clearing arrangements, noted the ICI. Protections should be provided to
indirect clearing arrangements, said the Institute, particularly if these
arrangements facilitate the ability of non-EU market participants to conduct
transactions in the EU or with EU counterparties.
The ICI
urged ESMA to revise the draft to provide indirect clients with an equivalent
level of protection as direct clients, as required by EMIR. Although
appreciative of ESMA for proposing an omnibus client account at the central
counterparty level for the purpose of holding assets and positions of indirect
clients, the Institute requested that indirect clients be provided the right to
request that individually segregated accounts be established at the central
counterparty level.
For OTC
derivative contracts that are not subject to the clearing obligation,
counterparties are required to mitigate risks by using different techniques
specified by ESMA. The ICI has concerns with these risk mitigation techniques. ESMA
proposes to require timely confirmation of transactions and specifies the
timeframe for confirmations. While supporting efforts to mitigate counterparty
risk by requiring parties to confirm transactions promptly via electronic
means, the ICI sought clarification with respect to the parties responsible for
the timely confirmations and has concerns with the timeframe imposed on all counterparties.
The ICI
also asked for clarification regarding the practical aspects of how
counterparties may comply with the obligation to provide timely confirmation.
Specifically, given the meaningful and practical differences among market
participants with respect to resources, readiness and expertise, the ICI
recommended that the confirmation obligation be required of the dealer, rather
than the client, with respect to the key economic terms of the transaction. The
parties can then negotiate and agree to the final terms of the confirmation to
be signed by the parties without a specific time limitation on this process.
.
If ESMA
disagrees with this recommendation and instead intends to require both
derivatives dealers and funds as counterparties to confirm and sign the
confirmation, the ICI asked the Authority to extend the timeframe from the end
of the same business day to a more realistic period of time and apply this
requirement on a proportionality basis. The speed of processing and agreeing to
a confirmation often depends on the nature of counterparties, noted the ICI,
and, while a derivatives dealer might have the resources and operational
infrastructure to execute same day confirmations, funds and their managers are
unlikely to have the operational systems in place to do the same. Mandating
funds to be equally subject to the obligation to execute a confirmation of the transaction
by the end of the same business day as a derivatives dealer would require funds
and their managers to undergo significant and costly systems modifications that
may not be feasible for a small to medium-sized investment manager.
Under
current market practices, the dealer will typically produce the confirmation
and the client
will then be allowed a sufficient amount of time to review and agree to this
confirmation. In many cases, the confirmation might not be agreed to by the
parties for several days or, in some cases, weeks. Moreover, although same day
entry into confirmations may be possible with certain derivatives that are
currently traded on electronic platforms operated by dealers, the same may not
be achieved with respect to other less frequently traded types of derivatives.
Therefore, the ICI recommended that, if ESMA
determines to require funds, in addition to their counterparties, to confirm
and sign the confirmation, the obligation should apply proportionately, taking
into account the nature of the counterparties, the class of OTC derivative, and
the scale and complexity of each counterparty’s operations.
With
respect to the risk mitigation practices of regular portfolio reconciliation
and portfolio compression, the ICI supports the proportionality approach
proposed by ESMA in that the frequency of portfolio
reconciliations should be appropriate to the characteristics of the portfolio.
The ICI urged ESMA to clarify that these practices should apply on an
individual fund or portfolio level in recognition of the fact that the regulations
for funds that are publicly offered generally apply at this level, treating
individual funds and series funds as if the separate portfolios were separate
investment companies.
For example, in the United States , in creating funds, a
sponsor may establish each fund as a new, separately organized entity under
state law or as a new series company, that has the ability to create multiple
individual mutual funds or series. The requirements under the federal
securities laws safeguard the assets in an individual portfolio from market or
other risks that may negatively affect another portfolio, and consequently the shareholders
invested therein and the fund complex more broadly. For example, liquidation of
one fund series is isolated to that series. The ICI understands that similar considerations
apply in the case of umbrella fund structures established in certain EU
jurisdictions, such as Luxembourg .
Thus, the ICI believes that contracts held across different funds under the
management of a single manager must not be aggregated for the purposes of
determining whether the relevant thresholds are met.
The ICI
supports the principle incorporated in the draft standards that stakeholder
accountability should be a key component of sound governance arrangements for central
counterparties. The ICI believes that
stakeholder involvement in the governance of central counterparties will minimize
conflicts of interests by balancing the commercial interests of central
counterparties with the interests of stakeholders. Given the importance of the
board of directors of a central counterparty in monitoring and controlling
conflicts of interest, reasoned the ICI, it is imperative that the composition
of central counterparty boards include stakeholder representatives.
Guaranteeing
stakeholder representation on the board also would level the playing field for
all central counterparties by creating a uniform governance structure in which
all of them will operate under similar restraints on the influence of their
owners. For similar reasons, the ICI urged ESMA to require risk committees of
central counterparties to include a wide range of client representatives. Since
central counterparty risk committees will be responsible for making decisions capable
of having profound effects on the OTC derivatives markets, reasoned the
Institute, market participants have a strong interest in ensuring adequate and
diverse stakeholder representation on risk committees as well as transparency
as to the committee’s decision-making processes.
Specifically,
the ICI asked that the draft require adequate representation of each category
of member of the risk committee included in Article 28 of EMIR, including
clients of clearing members and require central counterparties to disclose the
membership of their risk committees. Article 28 also provides that the
risk committee may invite employees of the central counterparty and external
independent experts to attend risk committee meetings in a non-voting capacity.