Confirmations. 1. Introduction

Transcription

1 Confirmations 1. Introduction 1.1. The British Bankers Association (BBA) recognises and supports the importance of a robust confirmation process, acknowledging the work that ISDA in particular has done in this area as it leads industry efforts to improve the overall processing environment for OTC Derivatives. This positive work has resulted extensive progress over recent years, as evidenced by industry meeting or exceeding successive ambitious targets as agreed with the OTC Derivatives Supervisors Group (ODSG) ESMA s publication of its draft regulatory technical standards (RTS) has introduced considerable uncertainty into this area however. Not only do the RTS lack the necessary definitional clarity regarding what the term confirmations means from an operational perspective (rather than what a confirm is), the BBA is also deeply concerned that ESMA s proposed implementation timetable for the confirmation timings between counterparties will prove both unrealistic and prohibitively costly to implement, especially in view of that fact that industry would fail to meet these obligations as they currently stand. This is especially so when considering its impact on small and medium counterparties, an industry demographic particularly vulnerable to unsuitable policy objectives While industry does favour phasing in more ambitious targets for confirmations and we do not disagree with the standards per we contend that in view of available evidence regarding current confirmations target, the implementation timetable set by ESMA should be reconsidered. 2. ESMA s Proposal 2.1. The Level 1 EMIR text requires financial counterparties and non-financial counterparties to have appropriate procedures and arrangements in place to measure, monitor and mitigate operational counterparty credit risk, including timely confirmation, where available, by electronic means, of the terms of non-cleared OTC derivatives, and mandates ESMA to specify these procedures and arrangements ESMA proposed RTS were 27 September 2012 and within it ESMA made a number of recommendations concerning these obligations. Delineating between OTC derivative contracts concluded between financial counterparties (FCs) and non-financial counterparties (NFCs) exceeding the clearing thresholds, and OTC derivative contracts concluded by NFCs below the clearing thresholds, ESMA proposed a timeframe for the confirmation ranging from the next business day following execution for the first category of counterparties to the second business day following execution for the second category of counterparties. The timing was extended by one business day when transactions are

2 executed after 4.00pm or with a counterparty located in a different time zone which did not allow confirmation by the set deadline When considering when to roll out these objectives, ESMA chose to adopt a staggered implementation schedule. Interim targets were established for periods ranging from the entry into force of the draft RTS, and progressively increasing in severity in August 2013, February 2014and finally August 2014, with ESMA asserting that these targets would allow interim enhancement of its timeframe before reaching its ultimate objective. This objective is the exchange of confirmations on the business day following execution for FCs and NFCs above the clearing threshold and the second business day following execution for NFCs below the clearing threshold The RTS appear to go beyond the Level 1 requirement for market participants to have procedures and arrangements in place for timely confirmation by mandating specific timeframes for counterparties for confirmation of non-cleared trades according to asset class and counterparty classification. We urge the Commission to move back from firm targets to a principles, policy-based requirement as envisaged under the Level 1. This would alleviate much concern amongst NFCs but still allow ESMA and national authorities to closely monitor industry progress in this area through the requirement to report confirmations outstanding over 5 business days. Figure 1: ESMA's confirmation implementation timeline 3. The Definition of Confirmation 3.1. During the RTS consultation, ESMA received significant industry feedback focusing on the need for greater definitional clarity over the meaning of the term confirmation 1. In particular, the BBA called on ESMA to explicitly exclude full legal execution as a possible meaning for confirmation, and to confirm that the dispatch of a document from one counterparty to another affirming the full terms of the contract (but not amounting to full legal execution) would satisfy its requirements. 1 ISDA-AFME-BBA-Assosim Response to ESMA Consultation Paper and Draft Technical Standards for the Regulation on OTC Derivatives, CCPs and. Trade Repositories, 6 August 2012, pp.41

3 3.2. Unfortunately, ESMA s publication of the RTS in September provided only limited clarity on this issue. With confirmation currently defined in EMIR as the documentation of the agreement of the counterparties to all the terms of an OTC derivative contract, the possibility remains that confirmation could include full legal execution, or extend even wider, with ESMA itself stating that it would not recognise some existing market confirmation practices, such as the where the full legal contract is exchanged but not signed, but that it may accept other positive current market practises in certain asset classes, such as negative affirmation (where, following the counterparties exchanging the term sheet, the terms are considered correct if the other counterparty has not responded within a certain time period) Not only does this lack of clarity have considerable ramifications for the ability of users of OTC derivatives to meet ESMA s proposed confirmation deadlines, should the term confirmation include full legal execution, we are extremely concerned about the considerable market impact that such a requirement would have on counterparties, particularly end-users and those who engage in very bespoke transactions (of whom a significant portion are non-financial counterparties). Given the considerable complexities involved in meeting a confirmation obligation which includes full legal confirmation, it is not realistically achievable for counterparties particularly small and medium counterparties - to meet ESMA s implementation timelines without enormous cost. This is particularly true where the OTC derivatives trades in question are not eligible for electronic confirmation With the RTS now being considered by the European Commission ( the Commission ), the BBA would welcome explicit confirmation from the Commission that, in the event that the term confirmation does include full legal execution, it also includes other forms of confirmation currently accepted as standard market practice. 4. Date of application of confirmation rules 4.1. The date when ESMA s confirmation implementation timeline begins is 20 days following publication of the RTS in the Official Journal. This date expected to be on or about the 1st March contrasts with the date of implementation of other nonmargin bilateral risk mitigation rules, notably those on portfolio reconciliation, portfolio compression and dispute resolution, which are expected to begin in August, or at the latest, 1 September As highlighted below, there are a number of reasons why ESMA s proposed confirmation requirements place a considerable burden on small and medium-sized market participants and those who lack either the operational experience or appropriate infrastructure to effectively meet their obligations. When this is combined with the staggered implementation across the portfolio of risk mitigation measures required by the RTS, it is not apparent that there is any tangible benefit in this approach for either industry or regulators. The BBA recommends that the commencement date of the confirmation requirements occur concurrently with that of the remaining risk mitigation measures.

4 5. Implementation deadline 5.1. As acknowledged by ESMA, in recent years industry has made significant and welcome progress in shortening average confirmation periods. Nevertheless, despite these efforts, industry as whole, and particularly NFCs, do not currently meet ESMA s proposed timelines, a situation attributable to the heterogeneous nature of market participants, the complex features of their trades and the varied nature of their capabilities. These fundamental considerations are unlikely to be significantly addressed by the conclusion of ESMA s proposed phase-in period, with the likely result being that despite significant expenditure of crucial resources, both financial and nonfinancial counterparties will not be compliant with their RTS obligations One of the key impediments preventing industry from complying with the confirmations target is the contrasting capabilities of financial counterparties and nonfinancial counterparties. In the RTS s associated Impact Assessment, ESMA explicitly recognises that NFCs, particularly those below the clearing thresholds, do not have the same resources and sophisticated systems dedicated to handling the operational risks of their OTC transactions, as FCs, because the relatively low volumes of their activity would not justify the associated costs 2. ESMA also accepts that the low level of eligibility for electronic confirmation within some asset classes crucial if counterparties are to achieve ESMA s confirmation objectives is largely attributable to the difference in market practices between FCs and NFCs, and their activity in commodities markets The confirmation s picture is further coloured when considering the relative results between and within asset classes. While there has been a considerable success in reducing confirmation timeframes overall, there remain key differences among asset classes, with interest rate and credit derivatives showing the highest rate of T+0 confirmations, (above 70% of trades normally confirmed on a same-day basis) while the figures for Commodity and Equity derivatives remain at relatively low (47% and 21% respectively). Contrary to ESMA s assertion that industry performance outside credit and rates has made little progress only because focus has been on these areas, this divergence is due to other, more fundamental factors, such as market participant capability and asset complexity 3. Timing is also an issue for complex trades and structured trades (where it is not unusual to take 30 days to execute a trade). Also, these trades are not typically confirmed electronically (as they tend to be more bespoke) It is largely due to these complicating factors that across all asset classes, 100% issuance of electronic and non-electronic confirmations does not occur until at least five days after trade date. While industry does recognise and is pleased that issuance of a significant proportion of trades occurs within the first one or two days after trade date, we are concerned that the small portion that takes longer does so due to complexity of the trade and the varied capabilities of the respective counterparty, especially non-financial entities. Additionally, delays may also be attributable to the need for significant negotiation involving multiple parties or, in the case of smaller and less sophisticated market participants, the seeking of external council or advice. 2 Annex VIII of the Final report on draft Regulatory and Implementing Technical Standards on Regulation (EU) 648/2012 on OTC derivatives, central counterparties and trade repositories, 27 September 2012, pp Annex VIII et al pp.31

5 6. While ESMA has acknowledged the differences between FC and NFC and those NFC below the threshold, their policy response creating staggered targets depending on the category but setting very ambitious timelines remains unachievable and, for many affected FCs and NFCs, beyond their capability. ESMA s believe that for NFCs above the threshold, it is likely that their level of activity and technological capacity would be close enough to those of FCs to justify the choice of having the same requirements is also unsupported by either analytical or qualitative analysis and ignores the considerable differences between sophisticated FCs and those NFCs for whom complex OTC derivative trading is an ancillary activity to their core business. Additionally, ESMA s belief that industry as a whole will be able to leverage what has been accomplished in the field of credit and interest rate derivatives does not pay due regarding the fundamental reasons why some confirmations remain outstanding beyond T Despite these complicating factors, as evidenced by the considerable effort expended by industry as it has worked with the ODSG to improve performance in this area, industry does support the intention of policy makers to advance confirmation performance. To that end, and leveraging off the considerable work already done in forwarding this agenda, we would encourage the Commission to adopt a more nuanced and flexible approach to implementation and one that affords due regard to the considerable difficulties counterparties will have as they attempt to meet ESMA s proposed confirmation obligation timeframes. We continue to encourage policy makers to work with industry in an effort to ensure that these obligations are effective, achievable and proportionate Regardless of the implementation timelines, we propose that for NFC which exceed the threshold, their more demanding confirmation obligations do not apply until at least a month after the NFC s status change. This will allow operations teams to adjust their procedures to the tighter timelines, lessening the regulatory burden for and compliance costs for NFCs. 7. The Commission s Q&A 7.1. In regards to the requirement that FCs report to the competent authority outstanding confirmations, this provision may be interpreted as capturing transactions that have not been confirmed within 5 business days of execution (rather than more than five business days after the relevant obligation deadline ). We would welcome the Commission addressing this question within its Q&A. Additionally, industry would benefit from guidance as to whether this report is a snapshot of every trade at month end that is still unconfirmed and aged more than 5 business days, or a monthly report showing all trades that were not confirmed within 5 business days during that month In Article 11(3) where an extension of time is allowed in circumstances where a transaction is concluded after 4:00 pm local time there is no provision for where counterparties are in different time zones. We would suggest that the reference to after local time should therefore be interpreted so that where either party is in a time zone where it is after when the transaction is executed, and then the extended

6 deadline will apply. Industry would welcome this point being clarified in the Q&A, however alternatively, the first part of the paragraph could be amended to refer to where a transaction... is concluded after local time in the time zone of at least one of the counterparties We would draw the Commission s attention to the absence of a definition for business day. In particular, when counterparties are dealing with different jurisdictions, counterparties need to be able to determine which jurisdiction determines whether something is a business day and which time zone determines the end of a business day. It would be helpful for the Q&A to clarify that the business day convention agreed by the parties in the contract would therefore apply, and that the business day convention of the location of the counterparties operations areas Should you have any questions on this or any other EMIR related manner, please contact Andrew Rogan, Policy Director, Capital Market s and Infrastructure, on Andrew.rogan@bba.org.uk, or on