02 April 2012

EBF comments on draft regulatory technical standards on risk mitigation techniques for OTC derivatives not cleared by a CCP

If the most adequate product type is made too expensive for the end user due to poor regulation, the end user may shy away from doing any hedging. At an overall economic level this would increase the systemic vulnerability, as hedging levels could generally decrease. This would be quite the opposite from what EMIR is trying to achieve.

Provided that collateral can be valued effectively, on a sufficiently frequent basis, and particularly in times of market stress, then there should not be specific restrictions on what collateral can be used.

Under the laws of any jurisdiction, the transfer of assets between different legal entities, even if belonging to the same group, is always subject to some legal restraints and/or requirements. Only extraordinary restrictions or requirements materially affecting a prompt transfer of own funds or repayment of liabilities should be considered to constitute such an impediment.

Banks remain concerned about the impacts of possible frontloading due to the potential change in the value of outstanding derivatives (losses/gains, hedging changes).

The EBF agrees that counterparties should be encouraged to use CCP’s whenever it is economically justified (hedging need, liquidity, transaction size, etc.). However, it does not agree with the view that market participants should be encouraged to use standardized transaction types just for the sake of it.

It is important to tease out the differences between risk management at CCPs and the bilateral market. Bilateral risk management is often more evolved, particularly when one party is a Prudential Financial Counterparty (PRFC) or Non-Prudential Financial Counterparty (NPRFC). Moreover, for many significant financial institutions, a robust and conservative prudential regulatory framework is in place that requires sufficient and stable equity to be held to cover the risk of potential losses. Finally, as currently envisaged, CCPs will not have tangible net worth (outside default fund commitments) whereas non-financial and financial parties generally do.

The EBF is of the view that the ability of an institution to implement a risk mitigation framework best suited to its specific needs and business model is a fundamental element of the European regulatory framework. The EBF therefore opposes requirements that would result in a rigid framework effectively impeding the implementation of a robust, yet risk and business specific, risk management framework.

This view is in contrast to the framework imposed on the centrally cleared OTC derivatives market. For CCPs, the objective is to minimise default risk rather than make a judgement on an acceptable level of such risk. This, of course, is required to ensure that these types of organisation can fulfil their role in the financial system.

Full paper

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