Monday, August 31, 2015

ESMA Seeks Input on Clearinghouse Margin, Considers Compromise with U.S.

By Lene Powell, J.D.

The European Securities and Markets Authority (ESMA) is seeking feedback on a new consultation paper addressing the amount of margin required to be collected by clearinghouses. E.U. and U.S. regulatory regimes provide for different methodologies in calculating margin requirements, which has led to a dispute over the lack of recognition of U.S. clearinghouses by the E.U. ESMA said it is considering allowing the U.S. methodology to be used for financial instruments other than over-the-counter derivatives, for client accounts for which margin is calculated on a gross basis. The agency is requesting comments by September 30 from key stakeholders including clearinghouses (also called central counterparties or CCPs), their clearing members, and clearing member clients.

Margin methodology controversy. Under a standard developed by ESMA and adopted by the European Commission, a clearinghouse should be able to either transfer or liquidate a position of a defaulting clearing member within a specified liquidation period, and have enough margins to cover the exposures arising from the transfer or liquidation of the relevant positions. The liquidation period is five business days for over-the-counter (OTC) derivatives, and two business days for financial instruments other than OTC derivatives. Margin may be provided for on a net basis, with clearing members only needing to pass through enough margin to secure the net exposure across a set of clients whose positions are held in the same omnibus account. This standard is referred to as “two-day net.”

In contrast, U.S. standards provide for a minimum liquidation period for non-OTC derivatives of only one day. Margin is collected on a gross basis, in which clearing members must pass to the CCP enough margin to cover the sum of the separate margin requirements for each client’s position, with no netting of exposures between clients. This standard is called “one-day gross.” A preliminary comparison of margin requirements showed that a one-day gross method typically, but not always, results in a higher level of margins held at the CCP. However, on a practical level, E.U. requirements may result in higher margin levels being maintained at both CCP and clearing member level, because in market practice EU clearing members tend to collect margin from clients on a two-day gross basis, and in fact are required to by some CCPs’ rules.

The difference in methodologies has generated significant controversy because in order for non-E.U. CCPs to be recognized and authorized to operate in the E.U., the CCP’s home supervisory regime must be considered “equivalent” to the E.U. regime. The European Commission has granted equivalence to a number of jurisdictions, but so far not the U.S, in part because of this sticking point over competing margin methodologies.

Possible change to E.U. standard. ESMA is investigating whether it would be appropriate to revise the current regulatory standard to allow CCPs authorized under the European Markets Infrastructure Regulation (EMIR) to apply a one-day liquidation period for financial instruments other than OTC derivatives, only where margins on client accounts are calculated on a gross basis.

As part of its investigation, ESMA asked a number of questions:
  1. What is the potential impact to the E.U. system if the margin period at risk (MPOR) is reduced at CCP level?
  2. If the standard were modified to allow one-day gross margin collection for exchange-traded derivatives (ETDs), should this be extended to financial instruments other than OTC derivatives? 
  3. If a differentiation of MPOR is made for ETDs depending on the gross or net collection of margins, should this differentiation be made for OTC derivatives as well? Would seven days MPOR for OTC derivatives be appropriate for net omnibus segregated accounts (OSAs)?
  4. Should individually segregated accounts (ISA) and gross OSA be treated equally in terms of MPOR?
  5. Should specific conditions be required in order to ensure that margins are called intraday in case the MPOR is reduced to 1-day under a gross client margins collection? 
  6. Should entities of the same group as clearing members not be allowed to benefit from a lower MPOR even if they chose an OSA gross or ISA account? 
  7. Should specific conditions (e.g. compulsory pre-existing arrangement with a back-up clearing member) be required in order to enhance the portability of client positions in order to benefit for the gross margining with one-day liquidation period? Would such a condition be feasible or might this be a practical impediment? 
Comments should be submitted online at by September 30, 2015.