June 2016 should see the European Markets
Infrastructure Regulation (Emir) come into effect. For buy-side
firms the rules have long been anticipated and discussed but
there are still very significant decisions to be made. The
rules represent Europe’s take on obligations to
clear and report over-the-counter (OTC) derivatives trades,
decided in 2009 by the G20 countries.
With Japan and the US having started
clearing in 2012 and 2013, Europe is playing catch-up. Its
highly democratic process of creating directives and
regulations is not geared towards efficiency. In this instance
the challenge has extended to international negotiation with
overseas regulators. For investment managers, there are several
issues which will require immediate action in order to ensure
their migration into the new clearing regime is as smooth as
possible, while any additional costs that the process incurs
are controlled within reason.
Transaction reporting has been a
requirement since August 2014 with mark-to-market valuations of
positions and on collateral value provided daily to trade
repositories, however there is no commonality in the level of
preparedness for other requirements, although larger firms are
commonly said to be far ahead of the curve.
"They are all ready to varying degrees,
ranging from completion to fairly early stages of engagement in
preparing for mandatory clearing," says Angus Canvin, senior
advisor for regulatory affairs at buy-side trade body the
Get in a
The first matter of concern is the
selection of a clearing broker to allow connectivity to the
relevant central counterparty. Many brokers are still
evaluating their own cost base and the viability of this
businesses. Several have been hard pressed to provide
transparent guidance around their Emir disclosure of fees, and
all emphasise that the costs are worked out with each client
individually. That can make the process trickier, however
the longer it is delayed the more problems can arise.
"Clients that have not selected clearing
brokers and are not live are definitely playing catch-up," says
Eugene Stanfield, head of head of derivatives execution and
clearing services at Commerzbank. "They run the risk of a
situation where the clearing brokers have limited or no
resource availability such as balance sheet or even from a
man-power perspective to on-board those
…with a local?
Another serious issue that requires
consideration is the lack of equivalence between the US and
Miles Courage, chief operating officer at
JPS Alternatives Group, a credit-focussed hedge fund says: "You
can form a view on a regulation in isolation but the critical
detail is often how it interacts internationally, especially
for managers with EU and US operations and offshore funds."
Despite the European authorities having
approved the majority of regimes in major Asia-Pacific
financial centres – bar China and India –
along with Canada, Mexico, South Africa and Switzerland, the US
has not passed muster. With disagreement over margin
requirements ongoing, there is no obvious reason for optimism.
Consequently investment firms are seeking to avoid exposure to
"Where clients are falling under Emir,
they are discontinuing relationships with brokers who are
subject to Dodd-Frank and vice versa," says Jörn Tobias,
head of Agent Fund Trading and Collateral Services at
custodian State Street.
Although the interpretation of the G20
2009 mandate has been nuanced in every jurisdiction, there are
reasons to think the global market will not be fractured, as
long as equivalence can be achieved, says Radi Khasawneh, Analyst, Fixed Income Research at Tabb
"We are seeing a proliferation of clearing
entities in regions and what the clearing entities and the
trade repositories do functions as a canary in the coalmine for
likely activity of the wider market," he said, speaking at the
Fixed Income Leaders Forum on 14 October 2015. "So after
trading venue and clearing house fragmentation into regional
silos, we expect to see them then reverse flow as they get
comfortable with equivalence where it exists, and then we will
see this huge dispersion start to reverse itself."
Getting and protecting
Moving to a cleared model, requiring both
initial margin to cover the value of a contract and variation
margin to cover changes in value will require a mechanism to
source the instruments needed for margin.
A major cost and/or risk for asset
managers will be the acquisition and protection of collateral.
For larger firms or those with funds that typically have the
assets required, either cash or high quality bonds, collateral
management may be viable in-house. However other firms will
need to weigh up if the value of outsourcing collateral
management to a broker or custodian can reduce the operational
costs or at least create a buffer to any future changing costs
by mutualising cost via a single supplier.
The challenge of developing and managing a
system also includes considerable risk and cost, where a tried
and tested platform provided by a third party can be delivered
more rapidly than an in-house system. A decision must also be
made about the account selected to protect those assets.
"There are a range of options available,
and not every clearing house has the same range," says
The two main categories of account come in
a variety of flavours, often with similar names. Typically the
options offered are for a fully or individually segregated
account in which the collateral held will be marked out and in
the event of a default by the clearing broker, the exact assets
can be returned as deposited. There is little or no co-mingling
of assets and they are held to support the initial margin for
only that client.
The second type is an omnibus account, in
which the account is shared by many firms whose net or gross
(both are offered) initial margin has to be covered by the
value of the assets held. This holds far less security in the
event of a default, but is decidedly cheaper.
"Clearing houses are offering the
buy-side, through the clearing brokers, omnibus account
structures which provide for the pooling of groups of clients,"
says Stanfield. "This can be preferential to clients who can
define their tolerance to fellow customer risk and select an
appropriate omnibus account pool or for end users such as fund
managers to aggregate all the funds under their management into
a closed omnibus account. These clients are effectively saying
they are happy for fellow customer risk but only to a known set
of end users."
Market participants report the two
extremes of the account range are typically the only choices
taken, offering the ability to choose between risk and
"It would be the end-investors who quite
rightly should be dictating according to the combination of
their risk appetite and then the cost they are willing to
bear," Canvin adds.