Specific clarifications regarding the re-use of collateral are foreseen in respect of the rules in the proposed SFTR (Article 15(2) of the proposal).
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1 13 May 2015 COGESI contribution for CMU on collateral management services (CMS) Introduction The Contact group on euro securities infrastructures (COGESI) consists of representatives of major market infrastructures and market participants and members of the Eurosystem, which gather regularly to address issues and developments in the field of collateral/liquidity management and post-trading activities in general. COGESI herewith provides a response on question 27 of the Commission s Green paper on building a Capital Markets Union (CMU) and identifying key elements for efficient collateral management services from an industry perspective. Question 27) What measures could be taken to improve the cross-border flow of collateral? Should work be undertaken to improve the legal enforceability of collateral and close-out netting arrangements cross-border? COGESI fully supports the key objectives of CMU to make markets work more effectively by encouraging the free flow of capital while reinforcing the resilience of the EU financial system. COGESI members also agree with the Green paper that the EU collateral market is fragmented and that cross-border fluidity of collateral throughout the EU is currently restricted. Fragmentation of the collateral market can be due to internal reasons (related to financial institutions internal collateral management) or external reasons (related to trade and post-trade processing chains for the administration/safekeeping of securities/collateral). While internal fragmentation can be reduced by institutions investing in collateral management services, reducing external fragmentation is a larger challenge and is the focus of this response. As an important building block of CMU, further work is needed to identify and assess the inhibitions of cross-border flows of collateral. COGESI has structured its concrete proposals to reduce external collateral fragmentation in three parts: (i) legislative action; (ii) market action; (iii) Eurosystem action. 1. Legislative action COGESI suggests that legislative action should be taken to reduce existing complexity resulting from multiple jurisdictions and remove existing impediments to cross-border collateral fluidity. Within these areas, a distinction could be made between long-term and short/medium term issues Reduce complexity from multiple jurisdictions: Page 1 of 8
2 Recent market initiatives, such as the establishment of interconnections/links between market infrastructures and the development of sophisticated collateral management services (CMS), aim to facilitate cross-border collateral management. While COGESI welcomes these initiatives, it points out that they cannot eliminate differences in jurisdictions which inevitably remain as a result of existing national laws. COGESI would see great benefit in having, in the long-term, a single EU rulebook (or single EU regulatory framework) for a number of key areas such as securities/collateral rules, insolvency laws, as well as taxation (e.g. withholding tax relief procedures). However, harmonisation of securities laws in the EU is complex as it involves changes to a wide range of legal concepts and structures (inter alia with regard to contract, commercial and company laws). In the short/medium term, specific areas could be improved to clarify the rights to realise/enforce and to (re)use collateral. This would reduce the need for costly legal opinions on collateral ownership rights and foster cross-border activities and the provision of cross-border services. - Acquisition of collateral/transfer of legal title: Further clarifications are required on rules that govern EU-wide acquisition of collateral. In particular, further information and transparency is needed in respect of the moment at which legal title transfer occurs for securities transactions (in the different layers/intermediaries of the collateral holding chain). In general, the transfer would occur with the credit/debit of securities to a securities account of the account holder (or the account holder s clients) or, alternatively, at the moment of settlement in the SSS 1. - Implementation of collateralisation techniques: Coherent rules are needed related to the conditions for the practical implementation of collateral legal agreements or collateralisation techniques (i.e. title transfer collateral agreements (TTCA) and security financial collateral arrangements - also referred to as pledge arrangements). The Financial Collateral Directive (FCD) has not been implemented consistently throughout the EU and it should be expanded beyond its current scope (e.g. beyond the current scope of the financial instruments that qualify as collateral and/or entities that qualify as collateral providers/takers). Greater emphasis is especially needed on national implementation of pledging requirements, because the use of pledge agreements is increasing for certain collateral structures, e.g. for segregation of CCP collateral or segregation of single assets (rather than value segregation which is achieved by TTCA arrangements). Pledge agreements are also increasingly used by certain players such as alternative investment fund (AIF) industry e.g. due to the new requirements under AIFMD requiring the AIF s depositary to appoint the tri-party collateral manager as a sub-custodian. The EU device of TTCA (whereby ownership rights are transferred) in the FCD should be preserved to ensure that any chain of collateral transactions is comprised of legally sound 1 Specific clarifications regarding the re-use of collateral are foreseen in respect of the rules in the proposed SFTR (Article 15(2) of the proposal). Page 2 of 8
3 distinct steps (thereby ensuring that the remainder of the collateral chain remains valid in case of any failure of point in the chain). - Conflict of laws: Clear and consistent rules are needed across account providers (and in particular intermediaries in collateral chains) as to which law applies to cross-border transfers of securities and the provision of collateral. A single conflict of laws rule would be beneficial in relation to the holding, acquisition and disposition of securities/collateral. - Insolvency: Collateral takers and collateral providers have a vital interest in the underlying legal framework being reliable and interpreted in a consistent manner across all Member States in case of insolvency. In particular, the close-out netting arrangements, and the redelivery of collateral securities must be legally clear and easily understood. The rules related to the insolvency of intermediaries in collateral chains and the intermediary s segregation of client assets from its own assets need to be harmonised 2. It is noted that the legal question of what would happen with securities/collateral in the case of the intermediary s bankruptcy also depends on regulatory requirements and compliance with the regulatory framework. In particular, cross-border holding of securities does mean that intermediaries and investors are confronted with other holding structures and regulatory requirements that they need to comply with. An operational approach could be applied, where minimum obligations are set for intermediaries upon opening and reconciling accounts. With regard to tri-party collateral management services, it is noted that tri-party agents have proven in the Lehman crisis that they can play an essential role in paying out collateral immediately to the collateral takers upon collateral giver default. In discussions of recovery and resolution regimes by policy makers, it is essential that collateral management service providers will only be impacted to the extent that delays linked to insolvency proceedings (such as stays in early termination rights) are required in the recovery and resolution process. The existing differences in insolvency laws also require costly efforts to provide pan-european CCP and collateral management services. In particular, with the collateral segregation requirements of EMIR, there is currently uncertainty whether CCPs have to provide to their clearing members a service that is compliant with (multiple) local insolvency laws, i.e. of the CCP, of the clearing member 2 In case of an intermediary s (account provider) insolvency, it should be clarified that the following conditions always apply: (i) account holders do not compete with the insolvent intermediary s creditors, (ii) account holders may instruct the insolvency administrator to transfer the securities to another securities account held with another intermediary and (iii) in case of a securities shortfall, the intermediary s proprietary securities are in priority affected to the insolvent intermediary s clients that suffer from the shortfall. Intermediaries should also on a continuing basis reconcile the securities positions they hold for clients with the amount of securities held uppertier (with another intermediary or with a CSD). This corresponds to art. 37 of the CSD Regulation. Page 3 of 8
4 and of connected clients of clearing member 3. Given the uncertainty and the efforts and costs for legal analysis, CCPs typically only offer their services at this stage for a limited number of combinations and have focused on the most commonly used jurisdictions of the European fund industry and the European clearing member industry. Because of the complexity of national insolvency laws, not all buy-side clients would have free access to segregation solutions which is not in line with the overall goals of the CMU. - Re-use and rehypothecation of collateral: Common rules on re-use and rehypothecation of collateral are beneficial to collateral fluidity (in particular in anonymous markets where there is no/limited possibility to check the validity of the collateral). Therefore, COGESI would welcome a harmonised framework for the re-use and rehypothecation of collateral and clarification of the conditions in line with the work carried out by the Financial Stability Board (FSB) 4. The EU has already taken significant steps on re-use through the introduction of Article 15 of the proposed SFTR. The rights of counterparties should be further protected when the conditions on re-hypothecation are clarified in line with FSB recommendations. Next steps: Given the importance of collateral management as a risk management process, COGESI calls for action to clarify and remove national legal barriers (that are not addressed yet by the existing Financial Collateral and Settlement Finality Directives). COGESI recognises the challenges and efforts related to the issue of securities law or to reform insolvency law. In the long run, and in view of finishing the single rule book, the proposal for comprehensive securities law legislation should be further analysed (in conjunction with cost/benefit considerations). This should be flanked by short to medium term action focussing on establishing further clarity and comparability of legal aspects among EU Member States on (i) valid acquisition of collateral, (ii) clarification of the conditions for re-use and rehypothecation of collateral and (iii) rights to realise/enforce collateral (regarding the insolvency of participants/intermediaries and related loss sharing and compensation mechanisms, and extension of conflict-of-laws rules). Concretely, a study should establish those cases where there are material problems which need to be addressed. The study should also take into account the market-led harmonisation efforts (see below), consistent with achievements being made in the context of T2S, and other meaningful improvements that underpin existing arrangements. COGESI stands ready to further explain the issues hampering the cross-border flow of collateral and collateral services in the EU. 3 4 Theoretically you could need 28*28 legal opinions (clearing member*client). This could even be extended considering the whole chain of clearing, i.e. by the clients of clearing member and their clients. The number of legal opinions needed to cover the EU market will jeopardize any business plan. See FSB Strengthening Oversight and Regulation of Shadow Banking, August 2013 (page 15). Some clarifications are foreseen on collateral re-use (with the proposed SFTR), focussing on transparency and protecting the rights of counterparties when re-using collateral and safeguards of client assets (with MIFID II especially related to the insolvency of the investment firm which prevents the use of the client s financial instruments on the firm s own account without the client express consent). Page 4 of 8
5 1.2. Removal of existing impediments on collateral fluidity (as short to medium term measures) In the long term, as explained above, having comprehensive securities law legislation in the EU would ensure that any assets deemed as eligible collateral can be utilised cross-border without legal impediments. In the shorter to medium term, any possible undesirable cumulative effects should be analysed, and where needed, common requirements should be implemented - Segregation requirements: Custody segregation requirements and optional segregation services have been introduced in the EU and globally with a view to enhancing certainty for who owns what collateral, increase transparency and therefore re-enforce investor protection. In general, there should be a consistent/common approach for segregation requirements with fair/competitive provision of services and choices for end-users. In some cases (e.g. where collateral is subject to processing from a pool of assets) the implementation of collateral segregation requirements will be difficult to implement and will reduce the efficiency of collateral processing, especially when involving fully segregated account structures (with assets and accounts segregated along the collateral chain up to the Issuer CSD level) 5. Custody segregation requirements have to grant sufficient flexibility for the use of collateral management and agency lending services by buy-side firms (dependent on the type of collateral arrangement agreed by counterparties and their needs/preferences). At the same time, COGESI agrees that these collateral management services should apply the general legislation/rules to ensure investor protection, increase transparency and reduce systemic risks, and these services should not undermine the overarching goals of the rules. - Settlement discipline (buy-in) requirements (SDR): Settlement discipline provisions and buy-in procedures in case of settlement fails (see CSDR, Short Selling Regulation) could impact the availability of collateral and collateral movements (see also industry impact studies e.g. by ECSDA and ERC). Additional to the SDR, appropriate market standards in messaging and market practices need to be agreed to avoid disruption of the post-trade lifecycle. There should also be acknowledgement that changes are needed at product level (e.g. to identify and report those repo securities movements which are subject/excluded from the mandatory SDR). - Understanding of combined collateral management requirements: COGESI calls for paying closer attention to the interplay of regulatory collateral requirements, i.e. the requirements on capital and liquidity (CRD IV, MMFR), clearing of transactions (EMIR, MIFIR), margin/haircut (EMIR, CRD IV, CSDR) and mandatory straight-through-processing/stp requirements (MiFID II/MiFIR). These combined requirements will increase the need for faster/better collateral management services on a cross-border basis. Close attention is needed on the limits of current services and the impact of 5 COGESI members explained that segregation requirements could introduce market settlement delays (with increased counterparty exposure) and could slow the collateral substitution, optimisation and movement process. Page 5 of 8
6 regulatory reforms on buy-side customers. Further work is needed to promote a sound understanding of collateral requirements and the functioning of the collateral management services across borders. Next steps: COGESI suggests to systematically examine the impediments on collateral fluidity. COGESI offers to explain in more detail current challenges that could be addressed in the short run, while fully supporting the primary objective of recent regulatory reforms to ensure investor protection and reduce systemic risks from the industry. Market-led actions, including self-commitments and best practice standards, should be taken into account (see below). 2. Market-led actions Market-led actions are relevant for efficient EU capital markets and could require legislative support when issues arise Increase neutrality on where the collateral is held and managed - Enhancements and interoperability: Further financial market infrastructure enhancements are needed for more effective collateral management across jurisdictions. In particular, (i) the enhancements planned by the (I)CSDs for interoperable links should be implemented to allow for highly efficient cross-border transfers, and (ii) collateral management service providers should develop interoperable collateral management services (triparty settlement interoperability) 6. Interoperable services require further market-led work on common processes, conditions and parameters for CMS (e.g. for repo, GC basket products, securities lending and OTC margining practices). - New technology and innovation: COGESI takes the view that new technology and innovation could facilitate more efficient collateral management. New tools are needed, such as services that record, mobilise, monitor and track collateral. Experiences and tools from other industries and services could be considered, such as distributed ledger technology. In order to have the right collateral at the right place at the right time, it is also important to open up collateral pools and develop models for access to a wide range of collateral eligibility types (including virtual collateral pools as long as risk and costs are fully transparent) Easier and wider use of CMS (including buy-side) - Harmonised market practices to foster automation of collateral processing: COGESI underlines the need for clear and harmonised market standards/processes on holding of collateral, management of 6 See COGESI report Euro repo market: improvements for collateral and liquidity management (July 2014). The enhancements of the ICSD s interoperable links will improve the flow of collateral up to late in the evening (including for treasury purposes late in the day) and as a necessary precursor to triparty settlement interoperability. Page 6 of 8
7 collateral, segregation of collateral and affirmation and confirmation processes (including the use, reuse or rehypothecation of collateral). Common market practices are also needed for the use of triparty agents (and agent lenders) to facilitate collateral management and for establishing increased transparency around the number of TTCA arrangements versus the number of pledge arrangements that the market uses. The implementation of the COGESI recommendations on Commercial Bank Money (CoBM) arrangements should also be taken up. This harmonisation of market practices is ongoing (covering T2S-related harmonisation work and industry work, e.g. on matching and affirmation). Common market practices should facilitate the access to global and open market infrastructures offering 24/5 collateral processing and posting across multiple markets and currencies. - Harmonisation of multilateral agreements/documentation for collateralisation: Current market agreements for repo, securities lending, derivatives and margining are often still bilateral. The industry should further investigate the possibility for standardised multilateral agreements, so that new participants could easily be on-boarded to collateralised markets, including the B2C/buy-side participants for repo or OTC margining. - Harmonisation of messaging standards: COGESI strongly emphasises the need for using state-ofthe-art global standards and practices for collateral messaging and transaction referencing (such as, for example, ISO 20022) Ensure transparency that is consistent across regulatory frameworks Recent legislative initiatives have aimed to enhance transparency on the volume of collateralised transactions and conditions for using collateral. Some of these initiatives may create some overlap and rely on multiple trade repositories for collecting and aggregating the reported transactions. COGESI is of the opinion that greater attention is needed to ensure that transparency requirements are consistent across the various initiatives to ensure efficient and effective regulatory reporting. - Harmonisation of reporting requirements for repo, securities lending and structured collateral transactions: The following regulatory frameworks with reporting requirements on collateralised transactions could be compared and be checked for consistency where applicable: in particular, reporting requirements introduced by SFTR, CSDR, EMIR and MMSR should be made as consistent as possible. Consistent reporting frameworks should be capable of satisfying the necessary requirements of applicable authorities. - Harmonised data elements and unique identifiers (in particular UTI and UPI) should be used to facilitate aggregation. Next steps: COGESI recommends that further work be done to identify improvements for the EU posttrade and collateral management practices/services, which take into account legal/regulatory conditions. Page 7 of 8
8 This further work supports (i) market innovation, (ii) harmonisation/standardisation and (iii) transparency; and could include the identification of post-trade industry target operating models and processing arrangements. 3. Eurosystem-action requested from market participants The Eurosystem operates the correspondent central banking model (CCBM) to enable all banks in the euro area to submit securities (marketable and non-marketable assets) as collateral for Eurosystem credit operations (i.e. intra-day credit in TARGET2 or Eurosystem monetary policy operations) regardless of where in the euro area the assets were issued, i.e. to facilitate that in principle each individual eligible asset can be mobilised by every Eurosystem counterparty ( level-playing field ). To recall, the CCBM model was introduced by the Eurosystem to overcome (temporarily) the lack of market-based solutions of links between Eurosystem eligible SSS. The Eurosystem introduced several improvements to CCBM in 2014, so that counterparties could mobilise assets both at the issuer SSS or at an investor SSS (if the securities are not held with the issuer SSS), provided that an eligible link exists between the issuer SSS and the investor SSS. In addition, triparty collateral management services offered by triparty agents (TPAs) on a cross-border basis are supported via the CCBM. - CCBM improvements: With a view to making cross-border flow of collateral for use in Eurosystem credit operations more efficient for the Eurosystem s counterparties, market participants in COGESI would see benefit in the further harmonisation of the (currently three) models and operational procedures of the TPAs. --- Page 8 of 8
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