Variation/initial margin and clearing

Transcription

1 Variation/initial margin and clearing Lessons learned and looking ahead to the new derivatives market Jonathan Quie Jason Valoti Simon McKnight 15 March 2017

2 Variation/initial margin and clearing Considerations for the sell side and buy side in APAC How the market implemented variation margin in key jurisdictions for APAC? Initial margin timetables, thresholds and implementation What we will be looking at today Can increasing derivatives clearing reduce the burden of complying with OTC margin obligations? 1 / B_LIVE_APAC1: v1

3 Regulatory developments in OTC Derivatives Reporting Clearing Risk mitigation for uncleared OTC derivatives Timely confirmation Processes to manage/identify risks 2 / B_LIVE_APAC1: v1 Portfolio compression Exchange of Margin

4 Variation Margin Jonathan Quie 3 / B_LIVE_APAC1: v1

5 Variation/initial margin and clearing Considerations for the sell side and buy side in APAC Background to VM rules VM rules in the EU parties directly/indirectly in-scope timing for implementation Key requirements Focus on Variation Margin Buy-side perspectives on the implementation of the VM Rules in Asia 4 / B_LIVE_APAC1: v1

6 Variation/initial margin and clearing Background to VM Rules Variation margin means the collateral collected by a counterparty to reflect the results of the daily marking-to-market of outstanding OTC derivative contracts. Focus on Variation Margin Collection of margin is intended to reduce the counterparty credit risk taken by parties that are in-the-money under an OTC derivative contract. VM reduces counterparty credit risk as, upon any default of the collateral-provider, the margin received by the collateral-taker is used to discharge the amount due from the collateralprovider under the derivative position. 5 / B_LIVE_APAC1: v1

7 Covered Entities Directly Covered EU Financial Counterparties (FC) Non-Financial Counterparties above threshold (NFC+) Certain exemptions apply. 6 / B_LIVE_APAC1: v1

8 EMIR Rules: FC/NFC+/NFC- Entity Type FC Details A financial counterparty (FC) includes: - a MIFID investment firm - a credit institution - a UCITS (and, where relevant, its management company) - an alternative investment fund (AIF) managed by an alternative investment fund manager (AIFM) which is authorised or registered in accordance with AIFMD - certain other EU regulated bodies such as insurance undertakings and institutions for occupational retirement provision. NFC + / NFC - Hypothetical FC/NFC+ A non financial counterparty (NFC) is any undertaking established in the EEA which is not a financial counterparty or a CCP (as defined in EMIR). An NFC is only subject to the clearing obligation if the average of the gross notional value of its OTC derivative positions over a rolling 30 day period (excluding hedging contracts) exceeds the relevant threshold (this kind of NFC is referred to as an NFC+). An NFC which does not exceed the relevant threshold is referred to as an NFC- an entity established outside the EEA which would be subject to the clearing obligation if it were established in the EEA (this is referred to as a hypothetical FC or NFC+). 7 / B_LIVE_APAC1: v1

9 Relevant Thresholds (EMIR) Clearing thresholds refer to the gross notional value of OTC derivative positions. Clearing thresholds for NFC+ Type of contract OTC credit derivatives OTC equity derivatives OTC interest rate derivatives OTC foreign exchange derivatives OTC commodity derivatives and other OTC derivative contracts not already mentioned Clearing threshold 1 bn 1 bn 3 bn 3 bn 3 bn 8 / B_LIVE_APAC1: v1

10 Variation Margin To whom do the EU VM rules apply? Dealer FC Hypothetical FC FC/NFC+ In-scope In-scope Client Client Hypothetical FC/NFC+ In-scope Out-of-scope* NFC Out-of-scope Out-of-scope * Unless direct, substantial and foreseeable effect in the EU or necessary as anti-avoidance Hypothetical NFC Out-of-scope Out-of-scope * Unless direct, substantial and foreseeable effect in the EU or necessary as anti-avoidance 9 / B_LIVE_APAC1: v1

11 Variation Margin Timing Both parties have uncleared AANA for March, April, May 2016 of over EUR 3 trillion 4 February 2017 Otherwise 1 March / B_LIVE_APAC1: v1

12 Variation Margin Implementation timing where are we now? 1 March 2017 deadline for documentation of VM compliant CSAs has passed. Other regulators in key jurisdictions have extended compliance deadline by 6 months/issued no-action letters. European Supervisory Authorities (the ESAs ) have published a statement in response to industry requests relating to operational challenges in meeting the deadline The statement does not provide or amount to the regulatory forbearance requested by the industry, and instead explicitly re-affirms the 1 March 2017 deadline for the obligation to exchange variation margin. 11 / B_LIVE_APAC1: v1

13 Variation Margin Implementation timing where are we now? However, the ESAs state that they expect national competent authorities ( NCAs ) to generally apply their risk-based supervisory powers in their day-today enforcement of applicable legislation including: the NCA taking into account the size of exposure to the counterparty plus its default risk counterparties documenting the steps taken towards full compliance counterparties putting in place alternative arrangements to ensure that the risk of non-compliance is contained (with a specific example of continuing to use existing Credit Support Annexes to exchange VM) the NCA taking a case-by-case assessment on the degree of compliance and progress. 12 / B_LIVE_APAC1: v1

14 EMIR VM Margin Rules Key Provisions Specified types of eligible collateral include: Cash US Treasuries (subject to specified minimum haircuts) Other highly liquid and high credit quality assets No wrong way risk Minimum Transfer Amount Permitted but may not be higher than EUR 500,000 (or equivalent) MTA is in respect of both VM and IM Two-way exchanges of margin 13 / B_LIVE_APAC1: v1

15 EMIR VM Margin Rules Key Provisions (contd.) 8% FX Haircut Percentage in respect of non-cash collateral. This is a statutory haircut aimed to address any FX risk to the extent such non-cash collateral is posted in a currency other than the currency of the derivative transaction. Daily collateral transfers Settlement Period EMIR provides for VM to be transferred generally on a same day basis The European Commission has recently clarified, however, that this requirement will be satisfied as long as collateral is provided on the same day (even if the transfer is not settled on the same day). 14 / B_LIVE_APAC1: v1

16 How are the VM rules being implemented? Repapering exercise Margin rules apply only on going forward basis (not to legacy trades) One VM CSA or two CSAs (a VM CSA and a non-vm CSA)? Bilateral amendment: Preferred approach for buy-side ISDA 2016 Variation Margin Protocol: Adherence + Questionnaire exchange (+ Supplemental Questionnaire) Amend, Replicate-and-Amend, New CSA, New ISDA Much more complicated than bilateral, but potentially easier from document management perspective 15 / B_LIVE_APAC1: v1

17 Variation Margin: Documentation Comparison of Methods Method Number of CSAs/Collateral Calls Treatment of Legacy Trades Preservation of Negotiated Terms Amend 1 Subject to margin regulations Preserved, to the extent possible under margin regulations Replicate-and- Amend 2 Not subject to margin regulations Preserved, to the extent possible under margin regulations New CSA 2 1 Not subject to margin regulations Subject to margin regulations Not preserved Not preserved 16 / B_LIVE_APAC1: v1

18 Implementation of VM rules Buy-side perspectives Many buy-side firms in Asia indirectly affected by new margin rules in relevant jurisdictions even if they are not directly in-scope Very significant repapering exercise but in general most CSAs already largely VM compliant (in terms of types of eligible collateral, haircuts on securities, MTAs etc.) Observations included: communication with buy-side: short notice of changes over-compliance (e.g. same day settlement for margin transfers) brokers systems/operations limitations unnecessary amendments changes to commercial terms not required by VM rules 17 / B_LIVE_APAC1: v1

19 Implementation of VM rules Buy-side perspectives Different approaches adopted by brokers to implementing VM rules Operational impact on funds (e.g. having two or more sets of operational procedures/margin calls if New CSA route elected). Even greater impact on buy-side in Europe (e.g. London based fund managers) as directly in-scope 18 / B_LIVE_APAC1: v1

20 Initial Margin Jason Valoti 19 / B_LIVE_APAC1: v1

21 Variation/initial margin and clearing Considerations for the sell side and buy side in APAC IM versus VM IM rules in the EU in-scope entities timing for implementation IM requirements documentation Focus on Initial Margin Comparison between margin rules in US, HK, SG and EU Key differences and similarities 20 / B_LIVE_APAC1: v1

22 Initial Margin What s the difference between VM and IM? Variation margin means the collateral collected by a counterparty to reflect the results of the daily marking-to-market of outstanding contracts. Initial margin means the collateral collected by a counterparty to cover its current and potential future exposure in the interval between the last collection of margin and the liquidation of positions or hedging of market risk following a default of the other counterparty. Although the valuation used to calculate the VM requirement will be continually refreshed, there is always some risk that the market value of a particular contract increases and a default occurs before additional VM is delivered. The IM requirement creates an additional buffer that is intended to reduce the risk of a shortfall in that scenario. IM, where applicable, is posted by both parties and the amounts to be posted are not offset against each other. 21 / B_LIVE_APAC1: v1

23 Initial Margin (IM) and Variation Margin (VM) IM: Protects against price movements between last collection and liquidation VM: Reflects current value of derivatives Netting set important IM: - Not netted - Levels of segregation (prop. or omnibus accounts) - Rehypothecation generally not allowed Counterparty A Segregated Account for IM B 22 / B_LIVE_APAC1: v1 IM A IM B VM ±IM A ±IM B Not all counterparties caught Acceptable forms of margin prescribed Counterparty B Segregated Account for IM A

24 Initial Margin In-scope entities The requirement to post and collect IM will only apply to transactions between: two FCs or NFC+s; or TCEs that would be FCs or NFC+s if established in the EU that both (or whose groups both) have a notional amount of uncleared derivatives in excess of the prescribed limits. The IM requirements are being phased in for transactions (see next slide). 23 / B_LIVE_APAC1: v1

25 Initial Margin Timing phased implementation Where both parties have uncleared AANA for March, April, May in Phase in relevant year of: Over EUR 3 trillion 4 February 2017 EUR 2.25 trillion 1 September 2017 EUR 1.5 trillion 1 September 2018 EUR 0.75 trillion 1 September 2019 EUR 8 billion 1 September / B_LIVE_APAC1: v1

26 Initial Margin How is AANA calculated? Aggregate Average Notional Amount (AANA) is: the average of the total gross notional amount of all uncleared OTC derivatives of an entity, calculated across its group, recorded on the last business day of the months March, April and May of the relevant year. The relevant days for the purposes of determining the AANA in respect of the first phase-in date were the last business day of March, April and May This calculation includes all uncleared OTC derivatives in a counterparty s group portfolio (including those not subject to IM or VM), but counting intragroup transactions only once. Physically-settled FX forwards, FX swaps and currency swaps exempted 25 / B_LIVE_APAC1: v1

27 Initial Margin IM Requirements How is IM calculated? How often is IM calculated? Rules require segregation of initial margin Exemptions Prescribed eligibility and valuation (haircut) requirements Haircut of 8% on cash and non-cash margin posted in a different currency 26 / B_LIVE_APAC1: v1

28 Initial Margin How is IM calculated? IM calculation methods must assess both changes in the risk position and market conditions. The RTS provide a standardised method for calculating IM but parties may instead use an IM model developed independently, jointly or by a third party agent. Where an IM model is used it must comply with the minimum requirements set out in the RTS. These are extensive and include: initial independent validation of the model the provision to the counterparty of all information necessary to explain the determination of IM ongoing performance monitoring to assess the IM model recalibration of the model every 12 months ISDA has developed a standard model (the SIMMTM) for use as an IM model with the aim of minimising disputes and discrepancies. 27 / B_LIVE_APAC1: v1

29 Initial Margin How often is IM calculated? IM is not only initial. It must be calculated within one business day of certain events including: the entry into a new uncleared OTC derivative the expiry or removal of an OTC derivative from the netting set a payment or delivery (other than margin) on an existing OTC derivative on certain reclassifications where the standardised method is used, and in any case where there has been no calculation in the preceding 10 business days. IM must then be provided within the business day of calculation. As in the case of VM, if the amount of IM required is disputed, the undisputed amount must be provided within the same timeframe. 28 / B_LIVE_APAC1: v1

30 Initial Margin Why is IM required to be segregated? As both parties are required to exchange IM, if IM were posted on a title transfer basis, it would increase the exposure of each party to the other. The RTS therefore provides that IM must be segregated to protect the IM from the default or insolvency of the collecting party. Equivalent protection is not required for cash IM. However, only central banks and certain regulated banking institutions are eligible to hold cash IM. The rules include a prohibition on the reuse of collateral posted as IM with an exception allowing for the reinvestment by a third party custodian of cash IM. 29 / B_LIVE_APAC1: v1

31 Initial Margin Why is IM required to be segregated? Diversification requirements apply where IM is posted and collected between systemically important institutions (SIIs) which mandate that no more than 20 per cent. of cash IM is held with a single third party custodian. For transactions involving SIIs and other counterparties (other than pension schemes) that post/collect more than EUR 1 billion in IM, the excess over EUR 1 billion must be diversified, including by ensuring that no more than 50 per cent. is exposed to the credit risk of a single custodian. 30 / B_LIVE_APAC1: v1

32 Initial Margin Exemptions If a party to a transaction has (or its group has) an AANA below the thenapplicable threshold (which will be EUR 8 billion at the end of the phase-in period in 2020), IM will not apply. If parties are subject to the IM requirements, the rules permit unrelated parties to agree that IM need not be collected where the total IM to be collected from a counterparty, at group level, does not exceed EUR 50 million. Where the collateral required to be collected exceeds the threshold, this can also be used to reduce the amount of IM to be collected by EUR 50 million. As the threshold applies at group level, this threshold can be allocated between group members. 31 / B_LIVE_APAC1: v1

33 Initial Margin Exemptions The rules also provide for an equivalent EUR 10 million threshold on a counterparty basis for intra-group transactions where the intra-group exemption does not apply. Parties can agree a maximum EUR 500,000 minimum transfer amount (or equivalent amount in another currency) in aggregate across IM and VM on a counterparty by counterparty basis. 32 / B_LIVE_APAC1: v1

34 Initial Margin IM documentation IM has necessitated new documentation for transactions subject to IM. The requirement for segregation means that an English law ISDA CSA (which provides for full title transfer) is not appropriate. Where a custodian is used, as is expected to be the case, custody agreements, security agreements and account control agreements will need to be negotiated. N.B. Custodian backlog for Phase 1 IM. 33 / B_LIVE_APAC1: v1

35 Collateral documents with VM and IM example diagram ISDA Master Trans. Trans. Trans. Trans. Trans. Trans. CSD for IM (2016) CSA (1995) CSA for VM (2016) Pre-EMIR OTC margin implementation Post-EMIR OTC margin implementation 34 / B_LIVE_APAC1: v1

36 Initial Margin What do I need to do now? If not already affected by Phase 1 implementation, consider whether AANA will exceed the threshold for Phase 2 implementation of IM rules in September 2017 or subsequent phases. If you may be affected by the Phase 2 implementation of IM rules in September 2017, consider legal and operational impact now. Don t leave it until August / B_LIVE_APAC1: v1

37 Comparative analysis of margin rules in the US, the EU, HK and Singapore Jason Valoti 36 / B_LIVE_APAC1: v1

38 Covered Entities Generally EU US HK SG Financial Counterparties (includes AIFs) Swap Dealers Security-Based Swap Dealers Financial Counterparties MAS Covered Entities Non-Financial Counterparties above threshold (NFC+) Major Swap Participants Major Security-Based Swap Participants Significant Non- Financial Counterparties HKMA Designated Entities 37 / B_LIVE_APAC1: v1

39 Covered Entities Some Margin Exemptions EU US HK SG Intragroup transactions* Intragroup transactions Intragroup transactions * Regulatory approval needed Intragroup transactions* Exempt altogether Covered bonds Physically settled FX forwards and FX swaps Non-Financial End User hedging Physically settled FX forwards and FX swaps Cross-currency swaps associated with the exchange of principal Physically settled FX forwards / FX swaps. Uncleared AANA for March, April, May of relevant year is less than SGD 5 billion Exempt from IM Physically settled FX forwards and FX swaps Cross-currency swaps Limited exemptions Minimum transfer amounts (max EUR 500,000) Minimum transfer amounts (max USD 500,000) 38 / B_LIVE_APAC1: v1 Minimum transfer amounts (max HKD 3,750,000) Minimum transfer amounts (max SGD 800,000)

40 IM Timings * USD threshold only available for Financial End User. USD amount determined over June, July and August of preceding year. Uncleared AANA for March, April, May of relevant year* EUR/USD 3 trillion HKD 24 trillion SGD 4.8 trillion EUR/USD 2.25 trillion HKD 18 trillion SGD 3.6 trillion EUR/USD 1.5 trillion HKD 12 trillion SGD 2.4 trillion EUR/USD 0.75 trillion HKD 6 trillion SGD 1.2 trillion EUR/USD 8 billion* HKD 60 billion SGD 13 billion 39 / B_LIVE_APAC1: v1 EU US HK SG 4 February Sep Sep Sep Sep Sep Mar Mar 2017

41 Hong Kong Rules Entities subject to the Rules Entity Type Subject to Rules Details Locally incorporated AI (including overseas branches) Yes Rules cover all branches Trade must be with a Covered Entity Foreign incorporated banking subsidiary of locally incorporated AI No subject to HKMA determination Conditional on such entity (i) not transacting non-centrally cleared derivatives of a significant amount relative to the AI as a whole; and (ii) being subject to effective margin standards in the jurisdictions where it is incorporated. AI incorporated outside of Hong Kong Intragroup Transactions Yes, in respect of trades booked in its Hong Kong Branch No subject to certain conditions (and subject to HKMA s right to require compliance to avoid circumvention of the Rules) Trade must be with a Covered Entity For AIs incorporated outside of Hong Kong it may apply substituted compliance and either comply with (i) the foreign jurisdiction which margin requirement the Covered Entity is required to comply with (ii) the AI s home jurisdiction, or (iii) in limited circumstances, a jurisdiction other than that AI s home jurisdiction. Conditions include: (i) Group is subject to group-wide supervision by HKMA or authorities in other jurisdictions; and (ii) Group wide integrated risk management function is established 40 / B_LIVE_APAC1: v1

42 Hong Kong Rules Covered Entities Entity Type Details Financial Counterparties Includes, and in each case only where only where such entity has an AANA of noncentrally cleared derivatives exceeding HKD 15 billion: - AIs - SFC licensed entities (holding Type 1, 2, 3, 4, 5, 6, 8, 9, 11 and 12 licences) - Mandatory provident fund schemes - Occupational retirement schemes - Companies authorised by the Insurance Authority to carry on any class of insurance business - Licensed Money service operators - Licensed lenders - Special purpose entities as defined in section 227 of the Banking (Capital) Rules, except where the special purpose entity enters into non-centrally cleared derivative transactions for the sole purpose of hedging; - Collective investment schemes as defined in the Securities and Futures Ordinance - Private equity funds - an entity that carries on a business outside Hong Kong and is engaged predominantly in any one or more of the following activities, (i) banking (ii) securities business (iii) management of retirement fund schemes (iv) insurance business (v) operation of a remittance or money changing service (vi) lending (vii) securitisation (except where and to the extent that the related special purpose entity enters into non-centrally cleared derivatives transactions for the sole purpose of hedging) (viii) portfolio management (including asset management and funds management), and (ix) activities that are ancillary to the conduct of these activities 41 / B_LIVE_APAC1: v1

43 Hong Kong Rules Covered Entities (Contd.) Entity Type Details Significant Non- Financial Counterparty HKMA Designated Entity An entity other than a financial counterparty that for a one-year period from 1 September each year to 31 August the following year has an aggregate notional amount of non-centrally cleared derivatives exceeding HKD 60 billion An entity designated at the discretion of the HKMA and not covered by the above entity types 42 / B_LIVE_APAC1: v1

44 Hong Kong Rules Collateral Requirements Eligible Collateral IM Requirements VM - Requirements - Cash Timing for Calculation: Timing for Calculation: - debt securities issued or fully guaranteed by a sovereign associated with a credit quality grade 3 or above - debt securities issued or fully guaranteed by a multilateral development bank - debt securities issued or fully guaranteed by a public sector entity associated with a credit quality grade 3 or above Every 10 business day or at the earliest possible time, and in no case later than T+1, after one of the following events: - execution of a non-centrally cleared OTC derivative transaction; - the non-centrally cleared OTC derivative transactions forming part of the netting set changes; or - the calculation methodology changes Timing for Delivery: Standard settlement cycle (by T+2) Segregation: Daily (by T+1) Timing for Delivery: Standard settlement cycle (by T+2) Segregation: N/A Rehypothecation: - Other debt securities associated with a credit quality grade 3 or above - Gold - Publicly traded equities included in the Hang Seng Index or any other main index Excluded: Securities issued by AIs or foreign banks, securities that would create wrong way risk and securities that would result in over concentration in terms of issue, issue type or asset type Haircut: Standardised schedule with 8% FX mismatch haircut IM should be segregated from collector s proprietary assets If a third party custodian is used for IM, the AI must ensure that the custodian meets certain criteria regarding its financial quality IM collector must provide posting party with the option of individually segregated IM Rehypothecation: Prohibited, save that IM collected in the form of cash may be reinvested by the collecting party or its custodian if: - Securities are properly segregated; - Funds are only invested in eligible collateral; and - Re-investment is based on an agreement between the parties Threshold: Where cumulative IM exposure from a counterparty is equal or lower than HKD 375 million, parties may agree in writing not to exchange IM 43 / B_LIVE_APAC1: v1 N/A

45 Singapore Rules Entities subject to the Rules Entity Type Subject to Rules Details MAS Covered Entity Non-MAS Covered Entity Yes provided conditions are met No Trade must be: (i) with another MAS Covered Entity or Foreign Covered Entity; (ii) booked in Singapore; (iii) the MAS Covered Entity has an AANA of uncleared derivatives booked in Singapore for March, April and May in an amount greater than SGD billion Intragroup Transactions No MAS Covered Entity need not undertake exchange of margins if the uncleared derivatives contract is entered into with a counterparty who is an entity belonging to the same consolidation group as the MAS Covered Entity 44 / B_LIVE_APAC1: v1

46 Singapore Rules MAS Covered Entities Entity Type Details MAS Covered Entities Includes all entities regulated under the Securities and Futures Act: - Banks licensed under the Banking Act - Merchant banks approved as financial institutions under Section 28 of the Monetary Authority of Singapore Act - Other licensed financial institutions Foreign Covered Entity A person operating outside of Singapore who, if operating in Singapore, would have been a person within the meaning of MAS Covered Entity 45 / B_LIVE_APAC1: v1

47 Singapore Rules Deemed Compliance Entity Covered Entity Applicable Rules MAS Covered Entity MAS Covered Entity or Foreign Covered Entity Deemed compliance with SG Rules where (i) the margin requirements it is subject to in a foreign jurisdiction are assessed to be comparable to the SG Rules; and (ii) the MAS Covered Entity can demonstrate that it has complied with the margin requirements of that foreign jurisdiction. Following the WGMR member jurisdictions, the following jurisdictions are deemed comparable: Australia, Canada, the European Union, India, Japan, Republic of Korea, Mexico, Russia, Singapore, Switzerland and the United States from the date these jurisdictions implement margin requirements. 46 / B_LIVE_APAC1: v1

48 Singapore Rules Collateral Requirements Eligible Collateral IM Requirements VM - Requirements - cash - gold - debt securities issued by central governments and central banks (rating requirement AAA and BB-) - debt of other issuers (rating requirement AAA to BBB-) Timing for Calculation: Every 10 business day or at the earliest possible time, and in no case later than T+1, after one of the following events: - execution or termination of a non-centrally cleared OTC derivative transaction; - significant market disruption occurs; - changes to the asset classification of existing trades ; or - the calculation methodology changes Timing for Delivery: Timing for Calculation: At least daily Timing for Delivery: Within the standard settlement cycle for the relevant collateral type but no than (T+3). - equity securities (including convertible bonds) in a main index of a regulated exchange - Unites in a collective investment scheme, subject to certain restrictions Excluded: Securities that would not be liquid, securities that would create wrong way risk and securities that would result in over concentration in terms of issue, issue type or asset type Haircut: Standardised schedule with 8% FX mismatch haircut Within the standard settlement cycle for the relevant collateral type but no than (T+3). Segregation: IM must be held with an independent third party on trust IM should not be mixed and must be held under distinguishable separate arrangements to that of the collecting party s proprietary money and assets Rehypothecation: Non-cash IM may only be rehypothecated for the purposes of hedging the IM collector s derivative positions arising out of transactions with the customer for which such IM was collected Threshold: Segregation: N/A Rehypothecation: N/A IM only needs to be posed where the cumulative IM exposure from to counterparty exceeds SGD$80 million 47 / B_LIVE_APAC1: v1

49 Clearing Simon McKnight 48 / B_LIVE_APAC1: v1

50 Variation/initial margin and clearing How central clearing works Benefits and risks of clearing Focus on Clearing Clearing rules in the EU Who is in scope? Timing for implementation Which products are in scope? Interaction with Margin Rules 49 / B_LIVE_APAC1: v1

51 Bilateral trade ISDA Master Agreement Party A Party B Credit Support Agreement 50 / B_LIVE_APAC1: v1

52 Cleared trade Party A Clearing House Party B 51 / B_LIVE_APAC1: v1

53 Client clearing model Principal model (UK) Bilateral trade remains (but subject to modified terms) (A) CCP Mirror trade executed between CM and the CCP (into a client account) (B) Margin flows through the structure (initial margin retained at CCP) Client A CM B Security Interest over initial margin in favour of client

54 Clearinghouse Clearing House Rules Clearing House Rules Clearing Member novation of trade to Clearinghouse Clearing Member Customer Agreement or amended ISDA Agreement Customer Agreement or amended ISDA Agreement Execution of trade Party A Party B 53 / B_LIVE_APAC1: v1

55 How central clearing works Clearing House closes out positions & uses margins and/or default fund contributions to cover losses Bank A Clearing member Bank B Clearing member It is vitally important that the Clearing House is financially robust Bank F Clearing member CCP Bank C Clearing member Bank E Clearing member Bank D Clearing member Default Protected from direct losses due to clearing membership

56 The benefits and risks of central clearing Potential benefits Reduced contagion Reduced Credit Risk Cleared trades will attract favourable risk weighting and hence reduce capital charge for most counterparties Risks Concentration Risk Limited Liability of clearing members Capitalisation issues (NB risk weightings against default fund) Better transparency Orderly Default Management Possibility of portability may reduce failure 55 / B_LIVE_APAC1: v1

57 EMIR Clearing Who is in scope? FCs, NFC+ and TCEs which are their hypothetical equivalents Category Category 1 Category 2 Category 3 Counterparty Type Clearing members for at least one of the classes of OTC derivatives subject to the clearing obligation, of at least one of the CCPs authorised or recognised to clear at least one of those classes FCs (inc. UCITS and FC AIFs) and hypothetical FCs NFC+ AIFs (ie EU AIF, non-eu AIFM + above clearing threshold) and hypothetical NFC+ AIFs which belong to a group whose AANA of uncleared derivatives for Jan, Feb and March 2016 is above EUR 8 billion Same entity types as Category 2 but below the EUR 8bn threshold Category 4 Other NFC+ and hypothetical NFC+ not falling with categories / B_LIVE_APAC1: v1

58 EMIR Clearing Phase-in and Frontloading Category 1 Category 2 Category 3 Category 4 G4 IRS 21 June Dec 2016 [21 June 2017]** 21 Dec 2018 EEA IRS CDS RTS 9 Feb Aug 2017 [9 Feb 2018]** 9 Feb Aug 2017 [9 Feb 2018]** 9 May 2019 Frontloading G4 IRS: 21 Feb 2016 EEA IRS / CDS: 9 Oct 2016 G4 IRS: 21 May 2016 EEA IRS / CDS: 9 Oct 2016 N/A N/A ** NB. 13 July ESMA CP proposing 2 year delay of start date for [FCs] in Cat 3 57 / B_LIVE_APAC1: v1

59 EMIR Clearing Which products will be subject to mandatory clearing? Class of derivative G4 Currency IRS: Products within class Basis swaps denominated in EUR, GBP, JPY, USD Fixed-to-float IRS denominated in EUR, GBP, JPY, USD FRAs denominated in EUR, GBP, USD Overnight index swaps denominated in EUR, GBP, USD EEA Currency IRS: Fixed-to-float IRS denominated in NOK, PLN and SEK FRAs denominated in NOK, PLN and SEK Index CDS: Untranched itraxx Europe Main Index, Series 17 onwards, 5 year tenor Untranched itraxx Europe Crossover Index, Series 17 onwards, 5 year tenor 58 / B_LIVE_APAC1: v1

60 What s next: deregulation? 59 / B_LIVE_APAC1: v1

61 Further Information: Welcome to elexica: Free access to our resources 24/7: articles, podcasts and specialist guidance on our microsites. High quality legal updates and current awareness alerts Information on our suite of navigator on-line subscription services including navigator: Derivatives and FX (which covers the key issues relevant to entities looking to enter into derivatives and FX spot contracts with counterparties on a cross-border basis). navigator: Funds (which covers the key issues which are relevant to entities looking to offer funds to local investors on a cross border basis) navigator: Share Disclosure (which covers what the major shareholding disclosure regimes look like in a variety of jurisdictions) 60 / B_LIVE_APAC1: v1

62 Contact us Simon McKnight, Partner, Hong Kong T E simon.mcknight@ simmons-simmons.com Simon is a derivatives and structured products specialist whose work spans a wide range of products, including equity, credit and commodity linked products in OTC, loan and notes format. His most recent work has focused on corporate equity derivatives such as margin loans and collar financings. Before that he worked on all forms of credit derivatives, equity derivatives, stock loans/repos and repackagings and spent a year working on the Lehman administration. Jason Valoti, Partner, Singapore T E jason.valoti@simmonssimmons.com Jason acts for international investment banks in relation to structured and OTC derivative transactions, synthetic and cash CDOs, CLOs and repackaged securities and other asset and fund backed structures, including Shariah compliant transactions. Jason also advises international investment banks in relation to equity and commodity linked note, warrant and certificate issues. In addition, he advises investment managers on structured debt capital markets transactions. 61 / B_LIVE_APAC1: v1

63 Contact us Jonathan Quie, Of Counsel, Singapore Jonathan specialises in derivative and structured product transactions, advising a wide range of international financial institutions on complex, bespoke equity, index and credit-linked structures. Jonathan has a particular focus on advising fund managers and other buy-side institutions on prime brokerage, derivative and other transactional documentation. T E jonathan.quie@simmonssimmons.com 62 / B_LIVE_APAC1: v1

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