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1 EU Transparency Register ID Number ESMA S rue de Grenelle Paris edex 07 France Deutsche Bank AG Winchester ouse 1 Great Winchester Street London E2N 2DB Tel +44 (0) Fax +44 (0) December 2015 onsultation on indirect clearing arrangements under EMIR and MiFIR. Dear Sir or Madam, Deutsche Bank welcomes the opportunity to provide comments on ESMA s consultation on indirect clearing under EMIR and MiFIR. Overall, we support ESMA s efforts to simultaneously review the indirect clearing rules under EMIR and MiFIR in order to develop a similar approach to indirect clearing for both over-the-counter (OT) and exchange-traded (ETD) derivatives. owever, there are important differences between these markets with regards to the types of accounts that are appropriate and practical within each context, and these differences should be reflected in the final rules. We acknowledge ESMA s intention to respond to concerns that market participants have previously expressed about the scope of the rules, the account structures that are required, and the manner in which the rules come into conflict with existing market practices and insolvency regimes. As proposed, the draft rules would require the implementation of highly and unnecessarily complex and costly account structures. Similarly, the introduction of an obligation of means creates uncertainty regarding how Ps, clearing members, and clients should proceed under a default management scenario. The following issues need to be taken into consideration regarding account structures, default management processes, and longer chains: It is not necessary for clearing members and Ps to offer a choice between two types of omnibus accounts in all markets. It is appropriate to offer choice between net and gross omnibus accounts to indirect clients clearing ETD, because net omnibus accounts are prevalent in that market. owever, in the OT markets it is not necessary to offer more than a gross omnibus indirect account to provide adequate protections. learing members should not be required to open and maintain separate accounts at the level of the P for each client offering indirect clearing services. Doing so would lead to an unnecessarily complex and onerous structure of accounts and impose costs at each level of the indirect clearing chain. It is sufficient for a clearing member to maintain one gross omnibus and one net omnibus account for all its indirect clients at each P. The obligation of means with regards to porting and the leapfrog payment does not adequately specify the efforts that clearing members must undertake. These efforts should be further specified and circumscribed, especially because clearing members may be subject to challenge hairman of the Supervisory Board: Paul Achleitner. Management Board: John ryan (o-hairman), Jürgen Fitschen (o-hairman), Stuart Lewis, Sylvie Matherat, enry Ritchotte, Karl von Rohr, Marcus Schenck, hristian Sewing. Deutsche Bank Aktiengesellschaft domiciled in Frankfurt am Main; Local ourt of Frankfurt am Main, RB No ; VAT ID No DE ;

2 under different insolvency regimes, and will face operational impediments to achieving porting and the leapfrog payment. The requirement to port is not practical and should be removed. Liquidation is the most appropriate and feasible outcome in a default scenario involving a direct client. The requirement in Article 5(8) that liquidation proceeds do not form part of the client s insolvency estate goes beyond an obligation of means and would be practically and legally challenging to implement. As a consequence it should be removed. lient entities have sufficient choice in the market, i.e., to become a direct client or a first level indirect client, or rely on equivalent protections through a client asset protection regime or appropriate contractual documentation with their brokers. As a result, longer chains are not required and the RTS should not apply below the first indirect client. We hope our comments and suggestions are helpful. Please let us know if you have any questions on the issues raised, or if you would like to discuss any points further. Yours Sincerely, Daniel Trinder Global ead of Regulatory Policy 2

3 Question 1: Do you agree with the proposed approach to require the choice between an omnibus indirect account and a gross omnibus indirect account with margin at the level of the P? hoice of accounts We do not agree that the rules should mandate a choice between two sets of omnibus indirect accounts in all circumstances. There are important differences between the exchange-traded (ETD) and over-thecounter (OT) derivative markets with regards to the types of accounts that are appropriate and practical within each context, and these differences should be reflected in the final rules. With regards to the draft MiFIR Regulatory Technical Standards (RTS), it is appropriate that indirect clients should be offered a choice between an omnibus indirect account and a gross omnibus indirect account for ETD. Paragraph 28 of the consultation paper states that With regard to ETD, indirect clearing arrangements have been traditionally and primarily based on net margining. Because the majority of indirect clearing arrangements in ETD are indeed based on net margining, indirect clients seeking a higher level of protections should be able to select a gross omnibus indirect account option instead, and clearing members should be able to offer such an option for indirect clearing of ETD that is not unnecessarily complex or costly. learing members should therefore offer and maintain a single gross omnibus indirect account at a P in addition to a single net omnibus indirect account at a P for all the indirect clients clearing ETD through that P. With regards to the draft EMIR RTS, it is important that net omnibus accounts are not routinely offered for OT derivative client clearing, where central counterparties (Ps) have generally offered gross omnibus accounts to clients who do not choose an individually segregated account (), in a manner that is consistent with the requirements of Article 39 EMIR. This is noted in paragraph 29 of the consultation paper. Furthermore, there is no requirement in EMIR that a P offer a choice of a gross omnibus account and another type of omnibus account. It is also not likely that OT market participants would choose a net omnibus account given the greater segregation available through the gross omnibus option. For these reasons it is neither necessary nor appropriate to mandate a choice for OT indirect clearing between a gross omnibus account and another type of omnibus account. An alternative omnibus account option should only be offered to OT market participants where the P and clearing member judge that there is sufficient market demand for such an alternative. It should not be required of Ps or clearing member to offer more than a gross omnibus account option as a minimum standard of account. Account structure We are concerned that Article 3(1) and Article 4(5) of the draft RTS require that a clearing member open and maintain separate accounts both omnibus and gross omnibus at the P for each client s indirect clearing clients. As drafted, the RTS appear to require that a clearing member maintains a separate account for each client s indirect clients and further specify that this level of segregation must be made available all the way down the clearing chain. This is an unnecessary additional requirement that goes beyond the intent of the Level 1 legislation and the existing levels of segregation that are available to direct clients. It is sufficient for a clearing member to maintain one gross omnibus and one net omnibus account for all its indirect clients at each P. Doing so provides indirect clearing clients with adequate levels of segregation without unnecessarily complicating the provision of indirect clearing services. The most effective way of achieving protections for indirect clearing clients in a manner consistent with the intention of Level 1 is first and foremost to ensure that indirect clearing services are available on a reasonable and cost-effective basis. This means that Ps, clearing members, and clients must be able to offer indirect clearing solutions to the market that are practical and feasible to maintain, as well as practical and feasible for indirect clients to implement. As presently drafted, however, the requirements in the draft RTS regarding account structure will present significant operational challenges and increased costs at all levels of the indirect clearing chain. This is because the requirements related to offering and maintaining the proposed account structures will increase for Ps, clearing members, clients, and indirect clients particularly in terms of the operational overhead related to the management of many new separate 3

4 accounts. Moreover, each participant in the indirect clearing chain will face increased legal and compliance costs related to their contractual agreements, as well as the various obligations in the RTS that apply to each type of indirect clearing participant especially where multiple obligations fall on single participants as the chain lengthens. Because these requirements will complicate indirect clearing and make it more costly to participate in an indirect clearing chain, they will lead to unintended consequences: the draft RTS could lead to a decrease in the availability and benefits of indirect clearing for end users, which is the opposite of the rules intended effect. It is not necessary for clearing members to offer and maintain the proposed level of account segregation to achieve protections equivalent to those envisioned in the Level 1 text. Indeed, ESMA notes in paragraph 20 of the consultation paper that the gross omnibus option allows the comingling of positions and collateral for several indirect clients in a single account, thus simplifying its operational set-up and processing. Secondly, gross margining has the objective to ensure an equivalent amount of collateral is distinguished between different indirect clients in the account as would be the case between them if they had chosen separate individually segregated indirect accounts. We agree with the assessment in paragraph 20. The ability to identify and distinguish indirect clients collateral in a single gross omnibus account at the P is similar to that with an individually segregated account for direct clients under EMIR. Furthermore, we agree with ESMA that a single gross omnibus account is simpler than multiple s from an operational perspective. In addition to it being unnecessary to maintain segregated accounts at the P for each client s indirect clients it is also operationally complex and impractical to do so. It is sufficient for a clearing member to maintain one gross omnibus account and one other omnibus account type in respect of the assets and positions of all of its indirect clients for each P. This will allow for a simpler offering of account types which will reduce the complexity of indirect clearing while offering segregation to indirect clearing clients. Based on a scenario where a clearing member facilitates clearing on three Ps to three clients who each have two layers of additional clients, the draft RTS would result in a change from an indirect clearing structure where the clearing member supports a minimum of six accounts today to a structure with in excess of 40 separate accounts. This greatly increases operational complexity and risk in both the position and margin management processes. The below diagram demonstrates the complexity of the proposed structure: lient 1 lient 2 lient 3 All lients P 1 P 2 P 3 learing Member lient Indirect Indirect lients lients (Election) (Election) Note: Multiple indirect clients to one client Key: = ouse Account = lient Account (Net Omni) = Net Omni = Gross Omni = Indirect lient (Net Omni) = Indirect lient (Gross Omni) = Account Deutsche Bank presently facilitates direct clearing access to nine European Ps and many of our clients support indirect clients. The operational overhead and associated legal, compliance, and credit risks of supporting the model proposed in the draft RTS would not be feasible without a large increase in the operational team supporting the service. These increased costs would not only be incurred at the clearing member level but throughout the indirect clearing chain. 4

5 As a consequence, the requirement that clearing members should open and maintain separate accounts for each client offering indirect clearing services at the level of the P, particularly in Articles 3(1) and 4(5), should be removed. Margin at the level of the P We agree with ESMA that indirect clients margin ought to be held at the P. Indirect client margin will be segregated on a gross basis at the P for indirect clients who opt for a gross omnibus account within the simpler account structure proposed above, i.e., within a single gross omnibus indirect account at the level of the P for all of a clearing member s indirect clearing clients. Within such an account a clearing member can identify and distinguish the collateral held on behalf of each indirect client within its books and records. For indirect clients who opt for a different type of omnibus account, the margin in respect of their positions will be segregated from the margin in respect of the client s house positions, allowing the clearing member to identify and distinguish collateral held on behalf of indirect clients from collateral held on behalf of clients. Article 4(7) of the draft RTS establishes that, for the purposes of indirect clearing, clearing members assume the responsibilities of managing the default of a direct client. The clearing member s ability to identify and distinguish indirect clients collateral held at the P means that it will be able to appropriately risk manage a client default within the proposed simplified account structure. It is not necessary for clearing members to maintain separate omnibus accounts for each client s indirect clearing clients indeed, these additional accounts would increase the costs and complexities of indirect clearing. Question 2: Do you agree with the proposed approach for the requirements related to default management? Do you think there are alternative level 2 requirements (compatible with the relevant insolvency regime situations and the level 1 mandate) that would achieve better protections? Article 4(7): Porting and the Obligation of means We do not agree with the requirements on clearing members related to default management in Article 4(7) of the draft RTS. The requirement that a clearing member contractually commit itself to trigger the procedures to port indirect clients positions to another client in the event of a client default is inadequately specified and exposes the clearing member to risks, particularly in respect of challenge by a client s insolvency practitioner in situations where a client has become insolvent. In paragraph 37 of the consultation paper it is recognised that the requirement to port can lead to conflictof-law scenarios involving different jurisdictions insolvency regimes. It is further recognised, in paragraph 41 of the consultation paper, that it is not always possible to guarantee porting, largely because of a lack of back-up clients. We agree with these assessments, and we acknowledge that ESMA had undertaken to address these complex issues via the the obligation of means through which the procedures to port are triggered, but specific porting results are not guaranteed. owever, as presently drafted, the RTS result in potentially open-ended porting requirements on clearing members that are subject to the same conflict of law concerns, as well as the same operational impediments to achieving porting in the market. In this respect there is a significant difference between the protections afforded to clearing members in the draft RTS and the protections afforded to Ps under EMIR. A P managing a clearing member default can rely on provisions of EU legislation (such as the Settlement Finality Directive) and, in certain cases, provisions of legislation of an EU Member State (such as Part VII of the ompanies Act 1989 in the United Kingdom). These provisions allow the P to carry out its default management procedures with a relatively low risk of challenge by an insolvency practitioner of a defaulting clearing member. owever, in 5

6 the draft indirect clearing RTS a clearing member takes on the default management function of the P with regards to its indirect clients, but does not enjoy the same legal protections as a P managing a clearing member default. As a result, a clearing member attempting to port an indirect client s positions as well as the assets in respect of such positions to another client could face significant legal challenges in addition to the difficulty of identifying an appropriate back-up client. Moreover, the draft RTS do not adequately specify the nature of the efforts that a clearing member must undertake to port an indirect client s positions in the event of a client default. It is not clear when a clearing member will have discharged its requirements in this respect, and how its commitment to triggering certain procedures is discharged. Given the practical barriers to porting, the commitment to trigger the procedures cannot be implemented in a manner that provides adequate certainty and legal protections for both clearing members and clients (direct and indirect). In sum, the requirement to commit to triggering procedures is not operationally practical, and it potentially exposes clearing members to a significant risk of challenge by a client s insolvency practitioner. As a result, the requirement that clearing members must attempt to port indirect clients positions within the obligation of means should be replaced with language that recognises that liquidation is the most appropriate and feasible outcome in a default scenario involving a direct client. Should ESMA feel that an obligation of means to port indirect client positions is required, the draft RTS should allow a clearing member to specify a timeframe within its contractual arrangements in which porting must occur before the clearing member is entitled to take additional remedial actions including the liquidation of positions. This follows the current approach for direct clearing arrangements as specified under EMIR Article 48(5). The draft RTS should also recognise that the requirement to attempt porting can only be undertaken within the constraints of the applicable insolvency laws and proceedings. Finally, the final RTS should specify carefully what flexibility and discretion clearing members have with regards to their obligation to trigger the procedures for porting and allow clearing members to specify conditions that are a pre-condition for porting. This is necessary to ensure that clearing members are able to adequately disclose to clients and indirect clients the likely outcomes of default management procedures and to ensure that clearing members can adequately risk manage the default of its clients. Article 4(7): The leapfrog payment and the Obligation of Means Similar to the porting requirement, Article 4(7) of the draft RTS contains an obligation of means relating to the leapfrog payment. Article 4(7) requires clearing members to have procedures allowing the prompt liquidation of the assets and positions of indirect clients following the default of the client, in case the transfer to that other client has not taken place. Where indirect clients are making use of gross omnibus accounts, Article 4(7) further requires that the procedures shall include the steps required to initiate the payment of the liquidation proceeds to each of the indirect clients. With regards to the leapfrog payment for clients using gross omnibus accounts, the draft RTS do not adequately specify the nature of the efforts that a clearing member must undertake to make leapfrog payments to indirect clients in the event of a client default. It is not clear when a clearing member will have discharged its requirements in this respect. The obligation of means for the leapfrog payment subjects a clearing member to the same risk of challenge by an insolvency practitioner of the client that arises with regards to porting. This is likely to introduce conflict between clearing members and their direct clients on default management procedures. It will also undermine the clearing member s ability to identify indirect clients in a timely fashion and determine whether or not it is legally allowed to make leapfrog payments to any particular indirect client. In addition, Article 5(9) of the draft RTS does not place an obligation on the client to provide the clearing member with sufficient information to identify the indirect clients except in the event of a default. It is therefore unlikely that a clearing member will have the necessary information to make leapfrog payments in a timely manner to indirect clients. 6

7 The obligation on clearing members to undertake procedures relating to the leapfrog payment under Article 4(7) of the draft RTS should therefore be clarified to specify the clearing member s obligations, especially in circumstances where the indirect clients of a defaulting client are not identifiable on a timely basis, and/or where such payment could be subject to challenge by an insolvency practitioner. These clarifications should also allow clearing members to identify situations where they are unable to make the leapfrog payment due to challenges relating to information about the client and the insolvency or other laws applicable to a particular default scenario as well as allowing clearing members to adequately risk manage the default of their clients. Article 5(8): The client s insolvency estate We do not agree with the proposed approach in Article 5(8) of the draft RTS requiring that clients shall ensure that any liquidation proceeds received by the client for the account of one or more indirect clients does not form part of the client s insolvency estate. As currently phrased, the requirement goes beyond an obligation of means and specifies a particular result that clients must realize. This places onerous and impractical demands on not only clients but also the other participants in the clearing chain, including clearing members. It is not clear under the draft RTS the extent to which clearing members will be responsible for ensuring that clients and indirect clients implement adequate arrangements and liable for ensuring that the Article 5(8) obligation is realized. Fulfilling the Article 5(8) obligation would require that bespoke contractual arrangements are put in place for each client that is providing both omnibus and gross omnibus accounts to its indirect clients. These arrangements will have to be bespoke because they will need to be consistent with the insolvency regimes applicable to each client. In light of these practical and legal challenges, and their inconsistency with the Level 1 requirements for client protection, the obligation in Article 5(8) should be removed from the final RTS in its entirety. Furthermore, the requirements under Article 5(8), as drafted, far exceed the requirements for clearing members under Articles 39 and 48 of EMIR and impose an obligation to achieve a particular result. These requirements do not allow for a scalable solution to be developed given the bespoke contractual arrangements that would need to be put in place. The added costs and complexities for clients to develop such arrangements may well lead to some clients ceasing to provide indirect clearing services, with less choice for indirect clients with respect to accessing the market. Question 3: Do you agree that the proposed approach adequately addresses counterparty risk throughout the longer chain by ensuring an appropriate level of protection to indirect clients? If not, are there alternative approaches compatible with Level 1? We do not agree. There are alternative approaches that are simpler and are compatible with Level 1. As outlined in our response to Question 1, it is not necessary to maintain a separate omnibus or gross omnibus account for each client s or indirect clearing client s indirect clients no matter where they are located in the clearing chain in order to provide protections that are compatible with the protections required under Level 1. In fact, individual accounts are potentially even more onerous to provide and maintain further down the chain. This is because the number of accounts that will be required increases at each stage as indirect clients maintain clients of their own: under the proposed RTS, each new clearing relationship will require the creation of a new account structure to support it. This increases operational complexity and makes it difficult and costly for indirect clients to provide additional clearing services into the market. We consider that client entities have sufficient choice in the market to: (i) become a direct client of a clearing member; (ii) become a first level indirect client; or (iii) be able to rely on equivalent protections by relying on a client asset protection regime or entering into appropriate contractual documentation with their brokers. 7

8 As a result, we consider that longer chains are not required and that the requirements of the RTS should not apply in respect of entities below the first indirect client. Question 4: For longer chains, what other details (liquidation trigger and steps, flow and content of information, other) should be taken into account or what additional requirements or clarification should be provided in order to avoid potential difficulties when handling the default of a client or an indirect client facilitating clearing services? Although we disagree with the requirement for longer chains, the RTS do not provide sufficient clarity on how certain provisions should be implemented for longer chains. The lack of clarity regarding the specific requirements that clearing members have under an obligation of means applies equally to four-part indirect clearing relationships as well as to longer chains. Furthermore, the application of the RTS to longer chains would lead to additional uncertainty regarding clearing members requirements in respect of indirect clients indirect clearing clients. With regards to making payments to indirect clients in longer chains in the event of a client or indirect client default, the draft RTS do not adequately specify the nature of the efforts that a clearing member must undertake. It is not clear when a clearing member will have discharged its requirements in this respect, or when (if at all) a clearing member s responsibilities are devolved to its clients in a longer chain. As is the case for four-part clearing chains, it is not likely that clearing members will have sufficient information to facilitate the steps required under Article 4(7) of the draft RTS. This is because Article 5(9) of the draft RTS does not place an obligation on the client to provide the clearing member with sufficient information to identify the indirect clients except in the event of a default. It is therefore unlikely that a clearing member will have the necessary information to make leapfrog payments in a timely manner to indirect clients. The potential for conflicts-of-law in a default scenario is even greater for longer chains as the number of clients and the number of jurisdictions and insolvency rules involved increases. For these reasons, the RTS should specify: i) that an indirect clearing chain is permitted as long as the first four parties in the chain are compliant with the RTS; and ii) that the RTS only apply to the first four parties in the chain. Question 5: Do you consider that the new provision assigning by default to the indirect client the choice of an omnibus indirect account following reasonable efforts from the client to receive an instruction is appropriate? If not, what other considerations should be taken into account? We agree. Question 6: Do you consider appropriate that the collateral provided on top of the amount of margin the indirect client is called for is treated in accordance with the contractual arrangements? We agree. Question 7: In view of the different amendments described above, do you consider that this set of requirements ensures a level of protection with equivalent effect as referred to in Articles 39 and 48 of EMIR for indirect clients? We agree. 8

9 Question 8: Please indicate your answers to the cost-benefit survey. In order to assess the impact of these RTS with respect to your activity and profile, please consider the following questions for each RTS separately: 1. Are you a user/provider of Indirect clearing services? Please provide an estimate of the proportion of your clearing arrangements that are indirect clearing arrangements. Deutsche Bank is a limited user of indirect clearing services in certain markets where we use carry brokering services. For most clearing activities we have direct clearing relationships. It is difficult to ascertain the extent to which Deutsche Bank provides indirect clearing services. Many of our clients offer indirect clearing services but our contractual and operational relationships with those clients do not afford us a full view of their indirect clearing activities, and we do not have direct contractual agreements with indirect clearing clients. 2. Please quantify to the extent possible each of the costs (IT, staff, legal, internal procedure and training, others) and benefits derived from complying with each of the two RTS, and the overall total. Please explain the drivers for the costs and your calculations. The requirements relating to managing the complex account structure proposed in these RTS would require several new full time employees (FTE), according to our internal estimates. These FTEs would be needed for the purposes of operational requirements including collateral management processing and reconciliation functions. The legal and compliance costs associated with the contractual arrangements that are required by these RTS will be also significant for instance, know-your-client requirements and external legal advice related to contractual negotiations and certainty for the purpose of compliance with the obligations on clearing members relating to default management. 3. In relation to the size of your business, would you describe those compliance costs as: Very low, Low, Medium, igh, Very high? Very high in relation to Deutsche Bank s clearing business. 4. Please indicate any other positive or negative market effects (liquidity impact, transaction costs, business model, client and revenue composition, others) that may arise as a result of the proposed requirements. Please be as specific as possible in your answers. Firms offering and using indirect clearing services will face the need to make substantial adjustments to their current business models if the indirect clearing requirements are unnecessarily complex, which will require that participants throughout the indirect clearing chain build new infrastructure, adopt new operational practices, and take on additional legal costs. 5. Do you expect broader market changes from the two RTS? If yes, please explain the expected effects (positive and/or negative) on market structure, competition, members of Ps, direct clients, indirect clients, others. As drafted, the RTS would result in clearing services that will be more costly for end-users because the operational and legal overhead related to the management of many new accounts will increase at each level of the clearing chain, including at the indirect clearing client level. Many clearing members, clients and indirect clients may elect not to offer indirect clearing services, which will lead to both a concentration of risk and a limitation of competition in the market. In this respect, the RTS would compound the regulatory and cost pressures facing clearing members on other fronts, for instance as a result of the inappropriate treatment of segregated collateral under the leverage ratio, and could have 9

10 a similar impact on the degree to which clearing services are available to end-users on a cost-effective basis. Question 9: Do you have any comments on the draft RTS under EMIR not already covered in the previous questions? Please see our response to Question 10. Question 10: Do you have any comments on the draft RTS under MiFIR not already covered in the previous questions? The text in Article 2(1) and Article 2(2) of the draft RTS confirms that ESMA recognises that where a clearing member is prepared to facilitate indirect clearing for a specific client, it should agree on bilateral contractual terms setting out the mechanisms for each complex and newly recognised commercial arrangement, within both the ETD and OT market. Article 2(1) of the draft MiFIR RTS states that Where a clearing member is prepared to facilitate indirect clearing, any client of such clearing member shall be permitted to provide indirect clearing services to one or more of its own clients, provided that the client of the clearing member is an authorised credit institution, investment firm or equivalent third country credit institution or investment firm. We do not believe that ESMA intends to require clearing members that facilitate indirect clearing to allow all their direct clients to offer indirect clearing services without regard to their particular commercial and risk profiles. learing members must be able to perform due diligence and risk assessments on every client and make determinations as to the commercial and contractual arrangements that are appropriate for that client. A requirement that clearing members cease to perform these assessments could immediately increase clearing members counterparty risk, and as such would be in direct contravention of Article 4 EMIR and Article 30 MiFIR. It is therefore important that the draft RTS do not remove clearing members capacity to perform such assessments before entering into commercial and contractual arrangements with their clients, and/or allowing those clients to offer indirect clearing services. 10