Alternative Investment Management Association

Transcription

1 Alternative Investment Management Assciatin Bank fr Internatinal Settlements CH-4002 Basel Switzerland Internatinal Organizatin f Securities Cmmissins (IOSCO) C/ Oquend Madrid Spain Submitted via t: cpss@bis.rg and fmi@isc.rg Dear Sirs, CPSS-IOSCO Principles fr financial market infrastructures 2 August 2011 The Alternative Investment Management Assciatin (AIMA) 1 welcmes the pprtunity t cmment n the Cnsultatin Reprt published by the Cmmittee n Payment and Settlement Systems (CPSS) and the Internatinal Organizatin f Securities Cmmissins (IOSCO) n Principles fr financial market infrastructures (the Cnsultatin ). AIMA members are active participants in the glbal financial market and, thus, regular users f imprtant financial market infrastructure. Our cmments belw fcus n thse CPSS-IOSCO principles fr financial market infrastructures (the Principles) which are f greatest imprtance t users f financial market infrastructure (indirect participants). Summary f AIMA s cmments We supprt CPSS and IOSCO in their wrk t set internatinal standards that will help develpment a rbust framewrk fr regulatin f financial market infrastructure peratrs. AIMA believes that: the Principles set imprtant internatinal standards applicable t essential market infrastructure firms; the Principles benefit thse market infrastructure firms t which the Principles apply, as well as direct and indirect participants and users f thse firms services; Principle 2 (Gvernance) shuld require CCP gverning bards t have at least ne bard member wh represents the interests f indirect participants; CCP risk cmmittees play an imprtant rle in the safe peratin f CCPs. Principle 2 (Gvernance) shuld state that such cmmittees shuld include representatives f bth direct and indirect participants, althugh n single grup shuld hld a majrity f the vting psitins; 1 AIMA is the trade bdy fr the hedge fund industry glbally; ur membership represents all cnstituencies within the sectr including hedge fund managers, fund f hedge funds managers, prime brkers, fund administratrs, accuntants and lawyers. Our membership cmprises ver 1,200 crprate bdies in ver 40 cuntries. 1

2 Alternative Investment Management Assciatin cllateral is prvided t cver credit expsure and shuld, in additin t the types f cllateral already listed in Principle 5 (Cllateral), include freign currencies, freign gvernment securities and the underlying f a cntract, where apprpriate; Principle 6 (Margin) shuld state that CCPs shuld be given access t exchange traded markets data feeds t allw them t value and clse ut psitins; crss-margining shuld be available fr indirect participants as well as direct participants (where full individual segregatin is prvided) (Principle 14 (Segregatin and prtability)); Principle 14 (Segregatin and prtability) shuld make it clear that individual accunt segregatin ffers prtectin fr indirect participant psitins and cllateral t the greatest extent pssible and that such segregatin shuld be at least ffered by direct participants t all indirect participants at the utset f a transactin; Principle 14 (Segregatin and prtability) shuld state that CCPs shuld be prevented frm using custdians fr segregatin f assets and psitins that are perated by, r affiliated with, direct participants; Principle 14 (Segregatin and prtability) shuld nt cntain references t segregatin f cllateral with the direct participant. Such an arrangement is unlikely t prtect the cllateral f an indirect participant if the direct participant defaults; Principle 18 (Access and participatin requirements) shuld state that gverning bards and risk cmmittees f the CCP shuld include representatives fr indirect participants (cnsistent with ur recmmendatin under Principle 2 (Gvernance)); CCP participatin criteria shuld be fair, bjective, risk-based and nn-discriminatry. Principle 18 (Access and participatin requirements) shuld make it clear that different criteria fr different types f financial entity shuld nt be used. AIMA s cmments We believe that CPSS-IOSCO s Principles prvide a high internatinal standard that shuld be met by each f the different types f infrastructure prvider. We fcus ur cmments n fur areas f imprtance t users f financial market infrastructure: (1) Gvernance; (2) Cllateral; (3) Segregatin and prtability; and (4) Access and participatin. 1. Gvernance Financial Market Infrastructure firms (FMI firms) are fundamentally different frm ther types f financial institutins in that, althugh they are generally cmmercial, prfit-seeking firms, they prvide utility-like services fr the financial system, intermediating risk, prmting transparency, helping maintain stability and serving ther rles in the public interest. Fr this reasn, the gvernance f FMI firms must balance the natural prfit-seeking interests f their wners and sharehlders with the intercnnecting functins and public gds they perfrm. In this regard, we are pleased that Principle 2 recgnises that gvernance f a FMI firm must cnsider these bjectives and take accunt f the views and interests f all stakehlders, including direct participants, indirect participants, and thers. This is particularly imprtant in the case f financial market infrastructure that is required by law t be used by participants active in the financial markets. Fr example, the Eurpean Unin and the United States have prpsed that cunterparties t eligible ver-the-cunter (OTC) derivatives must clear thse cntracts with a central cunterparty (CCP) and reprt the details f their trade t a trade repsitry. In ur view, if parties are required t use a CCP and trade repsitry, they must als be given a say in hw these bdies perate. 2

3 Alternative Investment Management Assciatin In the case f a CCP, part f the bard s rle will include risk management duties, such as the apprval f new prducts fr clearing and acceptance f new direct participants. As with CCPs in ther markets, it is pssible that direct participants will als wn stakes r have a cntrlling interest in the CCP. This may present a cnflict f interest, as the influence they have ver the CCP culd be used t further their wn business interests at the expense f the CCP and its users - this culd invlve preventing market rivals frm using the CCP services r preventing clearing f prducts that may therwise be mre prfitable in a nn-cleared, OTC envirnment. Thugh setting clear bjectives fr the bard will help prevent decisin-making based n self interest by direct participants and wners f CCPs, this alne is insufficient. Independent bard members will act as an imprtant cunterbalance and we supprt the CPSS-IOSCO prpsal tward this end. Alng these lines, indirect participants are als well psitined t cntribute t the decisin-making prcess. Indeed, in many jurisdictins, including the US and the EU, it is prpsed that cunterparties t eligible OTC derivatives trades shuld clear their trades thrugh a CCP. These cunterparties shuld have their interests represented n the gverning bard in the same way as direct participants, as they will face significant lsses if the CCP is mismanaged. We, therefre, believe that Principle 2 shuld be mre explicit and state that, as a matter f best practice, CCP gverning bards shuld have members wh prvide sufficient, direct representatin f the interests f indirect participants. Principle 2 als recgnises the imprtance f cmmittees that FMI firms will perate, whse rles will be t advise the gverning bard n issues such as risk-management and payment f executive cmpensatin. Risk cmmittees will play a particularly imprtant rle in CCPs, as their functin in the market will be t take bth sides f a given trade and in ding s take n and manage cunterparty credit risk. It is, therefre, vital that risk cmmittees are established at CCPs and that they perate effectively. The risk cmmittee plays an advisry rle t the gverning bard and, as such, need nt be made up f members f the bard, as stated in Principle 2. It will be imprtant that bth direct and indirect participants are represented n the risk cmmittee as they will be able t prvide valuable insight n hw the risk assumed by the CCP may be intercnnected with the parties wn risk and with trade activities that may impact the peratin f the CCP. The risk cmmittee shuld include representatives f all relevant grups (the CCP; direct participants; indirect participants, etc.), with n ne grup cnstituting a majrity f the grup. Principle 2 culd be imprved by making these pints mre explicit. 2. Cllateral / Margin AIMA believes that Principles 5 (Cllateral) and 6 (Margin) set imprtant standards n the types f cllateral that CCPs can accept and n the amunt and frequency f margin cllectin. We agree that acceptable cllateral is likely t be that which has lw credit and market risk and a high degree f liquidity. The Principles culd usefully include an indicatin f the brad types f cllateral that shuld be accepted. Fr example, immediatelyavailable cash funds denminated in the lcal currency f a CCP s cuntry f establishment, r ther widely used glbal currencies, is likely t represent the highest quality frm f cllateral and ne which requires little, r n, haircut t value. Highly rated gvernment securities are likely t represent the secnd highest tier f cllateral, as such securities are less likely t experience drps in value resulting frm perids f financial stress and may ften act cunter-cyclically as demand increases fr safe gvernment securities (i.e., a flight t quality). In the case f a derivative cntract that is cleared n a CCP, a further type f cllateral that shuld be cnsidered is the underlying currency, financial instrument r asset f the cntract that may be required at settlement, where this is apprpriate. The underlying currency, financial instrument r asset f a derivative cntract, in the case f a swap, wuld reduce the need t cnsider the deteriratin in value f the underlying cllateral as it is that currency, financial instrument r asset that wuld be prvided at settlement. CCPs shuld, in all cases, specify fr direct and indirect participants the types f cllateral they will accept and the haircuts that may apply. The same cnsideratins fr eligible cllateral may be used fr initial and variatin margin, althugh the Principles shuld als cnsider whether a mre limited scpe f eligible cllateral shuld be used fr variatin margin. Variatin margin, as nted in Principle 6, is paid frm ne party t anther party t settle any gains and lsses n the psitins, which are marked t market. Variatin margin, therefre, ensures that large expsures are nt accumulated and settled nly at the cnclusin f a cntract. Initial margin payments are intended t cver a party s ptential future expsure and are nt called upn unless ne f the parties defaults. Therefre, there is greater need fr cllateral prvided as variatin margin t represent the 3

4 Alternative Investment Management Assciatin highest quality cllateral as it will be used thrughut the life f the cntract, nt just upn pssible direct participant default, as is the case with initial margin. CCPs margin mdels shuld, preferably, be subject t bth regular review by natinal regulatrs and thrugh testing by the CCP t ensure they are risk sensitive. Margin payments shuld be limited t thse necessary t cver the CCP s credit expsure. As identified, part f prducing accurate margin mdels and methdlgies is the cllectin f reliable and timely price infrmatin. We believe that the Principles shuld state that ne way t ensure CCPs have reliable and timely price infrmatin is t guarantee CCPs access t price data feeds frm lcal exchanges. Natinal regulatrs shuld ensure that CCPs can access any exchange price data feeds upn request, n a nn-discriminatry basis and n reasnable cmmercial terms. Prtfli margining and crss-margining arrangements are tw ways in which the verall cst f prviding cllateral t cver trading psitins can be reduced withut impacting verall levels f risk. Additinal risk management and versight is needed in bth cases, hwever, t ensure that arrangements are effective and that risk is nt under-priced. In the case f crss-margining between CCPs, we believe the Principles shuld cnsider whether this is pssible between indirect participants that, thrugh their relatinships with direct participants, will face tw r mre CCPs. Crss-margining culd be beneficial t indirect participants and helpful in reducing their csts and recgnising ffsetting psitins. We recgnise that calculating margin requirements acrss tw r mre CCPs may be difficult since indirect participants d nt have the same relatinship with the CCP as direct participants, and that the CCP will have less infrmatin abut indirect participants fr the purpses f risk management. We believe that crss-margining fr indirect participants is pssible, but nly where they have full, individual segregatin f psitins and cllateral. This is anther reasn why we believe that indirect participants shuld be ffered this level f segregatin (see belw). 3. Segregatin and prtability As AIMA s members typically manage funds n behalf f institutinal investrs and high-net wrth individuals, they are under fiduciary and cntractual bligatins t ensure t the maximum extent pssible that the assets f the funds are prtected against lss. Fr thse funds which trade in financial instruments and cntracts where significant amunts f assets must be prvided as cllateral, it is particularly imprtant that the manager makes arrangements t mitigate the risk f ptential lss resulting frm their cunterparty s default. Where AIMA members face anther party directly, they will ften negtiate fr cllateral, psted as initial margin, t be segregated with an independent third party custdian. It is, therefre, desirable that the same high level f prtectin is maintained when a CCP becmes the cunterparty, especially given that many indirect participants will be mandated t use these FMI firms (see abve). We supprt much f the cntent f Principle 14 s cnsideratins. In particular, we supprt CPSS-IOSCO s explanatin as t why segregatin is imprtant in the market 2 and believe it is fully cnsistent with many f the arguments AIMA has made t the EU and US authrities. See, fr example, AIMA s nte n Segregatin attached at Annex 1, which may help CPSS and IOSCO develp this argument further. Principle 14 discusses tw frms f segregatin: mnibus and individual accunts (ften referred t as full segregatin ). Buyside firms have, in the majrity, expressed a preference that under new regulatry regimes fr CCPs being develped in the US and EU, full segregatin shuld be the primary type used r shuld, at least, be available and ffered t all indirect participants n a reasnable cmmercial basis. Althugh mnibus segregatin has benefits ver direct participants hlding psitins and cllateral themselves, where parties are fully expsed t the default f the direct participant, it des still leave the indirect participant pen t lsses beynd their cntrl. Omnibus segregatin wuld see the assets and psitins f all indirect participants being pled and segregated frm the direct participant s psitins and assets. In certain jurisdictins, where this is permitted, sme mnibus mdels are set up s that indirect participants each deliver margin n their psitins n a grss basis and direct participants deliver margin n the net psitin f the mnibus accunt t the CCP, with the excess margin remaining with the direct participants. 2 Sectin f the Cnsultatin. 4

5 Alternative Investment Management Assciatin Our first cncern with mnibus segregatin is that an indirect participant with assets held in an mnibus accunt will nly receive a pr-rata share f the asset pl underlying the accunts psitin shuld the direct participant default. If n indirect participants within the pl default at the same time and the assets are paid int the accunt in full, this shuld allw psitins t be clsed ut fully and fr assets t be returned t each individual indirect participant. Hwever, an indirect participant wuld be expsed t lsses if anther indirect participant within the mnibus accunt defaults at the same time and des nt fully margin their psitin (knwn as fellw custmer risk ). This is mre likely t ccur in the stressed market cnditins which cause the direct participant t default. An indirect participant within the mnibus accunt is, therefre, expsed t lsses f ther indirect participants with whm it has n relatinship and f whm it has n knwledge, meaning that it cannt manage this risk. If the defaulting indirect participant is small, then pr-rata lsses shared between ther indirect participants may be small; but if mnibus segregatin is the nly ptin, the default f large indirect participants may cause large lsses fr all indirect participants. A majr benefit f full segregatin is that, shuld the direct participant default, indirect participant psitins and cllateral can be transferred t anther participant with little interruptin t an investment strategy r hedging psitin. In an mnibus arrangement, hwever, such prtability culd be delayed cnsiderably, as individual psitins and cllateral are nt readily identifiable. This may result in significant market disruptins and higher replacement csts. While the entire mnibus accunt may be transferred, this is cnditinal upn anther direct participant having bth the necessary resurces and risk capacity t accept it. In practice, the psitins f the mnibus accunt wuld mst likely be clsed ut instead. Clsing ut f all psitins means there is greater incentive fr the indirect participants t mve away frm a direct participant as it appraches default in rder t prtect their wn psitins, creating a run n the direct participant, ptentially precipitating its failure. Individual accunt segregatin is likely t prvide greater market stability t all stakehlders. While the changever frm an mnibus structure t an individual accunt may entail certain additinal csts, these need nt be material and indirect participants have indicated a willingness t pay them fr the higher prtectin they affrd, much as they d in the OTC market currently. Where mnibus accunts are used, it may be pssible t mitigate sme f the fellw custmer risk by requiring direct participants t reprt daily t the indirect participants n their pr-rata share f the mnibus accunt. This infrmatin wuld allw indirect participants t assess the level f fellw custmer risk and cmpare the amunt f margin being demanded by the CCP with the amunt f margin being delivered by the direct participant, based n the net psitin f the pl. If the rati f margin demanded by the direct participant against margin delivered t the CCP is high, this wuld indicate a greater ptential fellw custmer risk and that greater amunts f the indirect participants margin are being held as excess margin by the direct participant, nt delivered t the CCP. This level f detail wuld first allw indirect participants t assess the risk f mnibus segregatin and make a mre infrmed decisin n whether r nt t request individual accunt segregatin. Secnd, it wuld give indirect participants a clearer picture n the level f cunterparty risk t their direct participant. It may be that there is a rle fr the CCP in verifying these reprts n psitins and margin depsited t the indirect participants (if they agree t take this rle). Althugh CCPs will knw certain details required fr such reprts and indirect participants falling within the CCP s rules, the lack f a direct relatinship between the CCP and the indirect participants may make this task difficult. This additinal level f reprting shuld be recmmended by the Principles. Even with this additinal reprting requirement, mnibus segregatin wuld still nt permit individual indirect participants psitins and cllateral t be transferred t a new direct participant fllwing a default (but it wuld put indirect participants in a mre infrmed psitin regarding making a decisin t mve befre a default). Further, it wuld nt allw indirect participants t identify the ther indirect participants in the mnibus accunt and s fellw custmer risk will still be difficult t prperly assess and mitigate. If the gal f Principle 14 is fr CCPs t prtect indirect participant psitins and cllateral t the greatest extent pssible, then we believe that Principle 14 shuld clarify that this means individual accunt segregatin and that such segregatin shuld be at least ffered by direct participants t all indirect participants at the utset f a transactin. 5

6 Alternative Investment Management Assciatin Principle 14 als states that such CCPs shuld maintain custmer cllateral and psitins in an mnibus accunt r in individual accunts at the CCP r its custdian (emphasis added). We supprt CCPs using custdians and believe it may be peratinally efficient fr them t d s. When a CCP uses a custdian, hwever, it must be sure that the same level f segregatin is prvided by the custdian and, further, that the indirect participants and direct participants assets and psitins are segregated frm ther assets and psitins held by the custdian. A further risk may als present itself if the custdian used by the CCP is perated by r is an affiliate f any f the direct participants f the CCP. The failure f the direct participant shuld nt have any direct impact n the slvency f the custdian and CCPs shuld be prevented frm using custdians that are perated r affiliated with direct participants. This cnsideratin shuld be included within the Principles. Paragraph states that Segregatin f custmer cllateral can be achieved in different ways, including thrugh individual r mnibus accunts that may be held at the CCP, a third party custdian, r the participant (emphasis added). We questin whether segregatin f cllateral will be effective if held by the direct participant itself, as the direct participant s ability t segregate cllateral held fr an indirect participant upn inslvency will vary depending n the lcal legal framewrk. It is assumed that the Principles are, in fact, referring t segregatin f excess margin by the direct participant, where they cllect margin frm individual indirect participants in an mnibus accunt n a grss basis but pst margin t the CCP n a net basis fr the mnibus accunt, hlding the excess at the Participant level. Such excess margin will nt be prtected by the CCP if the direct participant defaults but will be subject t arrangements t prtect that cllateral as are agreed between a direct and indirect participant r as are specified by the relevant jurisdictin s client assets and mney rules. Even where assets are segregated by the participant, natinal inslvency law will usually require payments t be made nly nce the estate has been reslved and all claims investigated. In the UK, fr example, fllwing the cllapse f Lehman Brthers, clients (whse assets were suppsed t be prtected in a manner similar t segregatin under natinal inslvency law) had t bring claims thrugh the curts and funds were nly released a number f years after inslvency had been declared. This wuld equally prevent the transfer f assets t anther direct participant if assets need t be released frm an inslvent estate fllwing a judgement f a natinal curt. Fr this reasn, we believe Principle 14 shuld remve references t segregatin f cllateral with the participant itself. It is imprtant that segregatin is effective under natinal inslvency law and cuntries shuld cnsider which changes t their laws are required t give effect t the prtectin f indirect participants assets upn inslvency. A further issue that culd be cnsidered in the Principles is that where, thrugh peratinal failures, failures t keep prper recrds r fraud, assets and psitins are nt, in practice segregated, these culd be deemed t be segregated by law. Withut deeming segregatin t be effective in this way, there is little incentive fr direct participants t cmply with segregatin as, upn inslvency, they are unlikely t be subject t financial fines and may nt have the available assets any lnger t meet the agreed segregatin. If the Principles were t recmmend deemed segregatin, further cnsideratin f cmpeting interests upn inslvency may be required, as shrt-falls in cllateral made up by deeming segregatin t be effective wuld likely cme at the expense f rdinary creditrs. 4. Access and participatin We believe that Principle 18 prvides useful standards as t hw FMI firms shuld mnitr and permit participatin f direct participants and prvide access fr indirect participants t their services. Participatin requirements are particularly imprtant in the case f CCPs, which are designed t bth manage and reduce cunterparty credit risk and thus benefit frm as wide participatin as pssible. Where direct participants f the CCP bth cntribute financial resurces and are cunterparties capable f taking n psitins f defaulting participants, the greater the number f direct participants wh can prvide thse resurces, the mre effective and safer the CCP will be. Further, a greater and mre diverse membership can bring imprtant expertise n t gverning bards and risk cmmittees. Diverse participatin strengthens the verall system and the aim shuld be t have a large number f direct participants, the CCP giving due cnsideratin nly t whether a ptential direct participant has the peratinal capacity and a minimum level f resurces t cntribute. We disagree with 6

7 Alternative Investment Management Assciatin the statement in paragraph that an FMI may want t limit direct participatin t certain types f entities. If any type f ptential participant meets the bjective, risk-based criteria, it shuld be permitted t becme a direct participant in the interests f encuraging wide participatin and pening up market cmpetitin. If criteria are used t decide whether an indirect participant can be given CCP access via a direct participant, these shuld, as stated in the Cnsultatin, als be bjective and risk-based. Cnclusin AIMA supprts CPSS and IOSCO s prpsed revisins t their existing Principles fr FMI firms. The new Principles will hpefully prvide a set f high level standards fr natinal regulatrs t fllw as they implement new regulatry regimes fr FMI firms in their jurisdictins. We urge CPSS and IOSCO t cnsider the rle and interests f indirect users f FMI firm services and t incrprate ur recmmendatins t prmte a fair, balanced, and efficient marketplace fr all participants. We thank yu fr this pprtunity t cmment n the Cnsultatin and we are, f curse, very happy t discuss with yu in greater detail any f ur cmments. Yurs faithfully, Jiří Król Directr f Gvernment & Regulatry Affairs 7

8 Annex 1 AIMA nte n the Segregatin prvisins f the Eurpean Market Infrastructure Regulatin (EMIR) Backgrund In the ver-the-cunter (OTC) derivatives market tday, clients (e.g. hedge funds, pensin funds, crprates, etc cllectively the buyside ) f derivative dealers (e.g. banks the sellside ) trade utside f regulated markets and bilaterally clear their cntracts. Bilateral clearing invlves, in mst instances, the client prviding cllateral as security against the fulfilment f their bligatins in the frm f initial margin payments (e.g. cash r securities). Cllateral, as a default psitin, is held in the accunts f the derivative dealer fllwing title transfer f securities r payment f cash. The dealer is therefre able t use the assets as their wn, reinvesting the assets, subject t permissin being granted by the client. In this situatin, if the derivative dealer were t becme inslvent, the client s margin under inslvency law wuld frm part f the inslvent estate f the dealer and the client wuld be left with a creditrs claim ver their assets and culd expect a reduced return n the value f assets prvided (a pr rata creditrs claim), and significant delay in receiving thse assets whilst the dealer s business is wund up. T address this, sme buyside firms have negtiated (at reasnable cst) fr their asset t be held independently f the dealer in a single, client-specific accunt with a third party custdian ( segregated ), and fr the dealer t have rights ver the assets nly as prvided fr under a tri-party custdian agreement (i.e. where a client is ut f the mney under the derivatives cntract). Shuld the dealer becme inslvent, the assets wuld nt be subject t inslvency prceeding and may be returned t the client prmptly. In the futures market, where cntracts are ften traded n exchange, central clearing services have been prvided and cllateral has been segregated frm the dealer with the clearing huse r with a third party custdian. Assets have been held in mst cases cllectively in a single pled accunt knwn as an mnibus accunt. On the inslvency f a dealer, the clearing huse prviding the central clearing service will seek t fulfil the bligatins f the dealer t their clients t d this they will be permitted t use assets psted as margin fr the benefit f the dealer. Shuld any client have nt psted sufficient margin in the client mnibus accunt (thus leaving a shrt-fall) thrugh becming inslvent itself (a duble default ), the clearing huse will be permitted t tp-up the amunt f the shrt fall in the dealer s accunt by using the assets f ther clients in the dealer s client mnibus accunt in a pr rata manner. In additin, in an mnibus accunt, clients face risk f a deteriratin f the value f assets in the mnibus accunt that the dealer wuld nt be able t tp up. Any lss resulting frm such deteriratin wuld be shared pr rata amng the clients. Prpsed segregatin fr centrally cleared OTC derivatives As we understand it, the Eurpean Cmmissin has prpsed in the Eurpean Market Infrastructure Regulatin (EMIR), Article 37, that the assets f a client psted as margin must be segregated frm the assets f the derivatives dealer. This presumably culd be a range f mdels, including the mnibus mdel, where the client s assets are separated frm the dealer but nt frm ther clients. Clients may als have mre detailed 8

9 segregatin which we understand t mean full segregatin where assets are segregated frm the dealer and frm the dealer s ther clients. Ideally we wuld prefer fr all derivatives dealers t prvide full segregatin n all derivatives trades. If full segregatin remains as an ptin nly, it shuld be described in much greater detail in rder t achieve the intended plicy bjectives and legal certainty. We d nt believe that the language f Article 37 is sufficiently clear n this pint r wuld prvide the prtectin the buyside needs. The language in Article 37 must be imprved, and where sufficient clarity cannt be btained in the level 1 Regulatin, further detail shuld be prvided in implementing measures (which are currently lacking). We believe the gals f segregatin shuld be: A basic requirement fr physical segregatin f client assets (initial margin and excess payments given frming the psitin) frm the assets f the derivatives dealer ( basic segregatin ). Only initial margin shuld be required t be segregated and nt variatin margin, which services a different purpse; Ensuring that physical segregatin creates effective legal segregatin, resulting in assets nt being available t the administratrs f an inslvent derivatives dealer fr payment t creditrs r therwise being cnsidered the derivative dealers wn assets and subject t any natinal inslvency prvisin. This shuld be achieved by having the client s margin safeguarded and depsited with an independent third party; Fr derivative dealers (with whm the client cntracts) t ffer, and fr the clients t have the right t chse, full segregatin f assets where the clients assets are held independently, and physically and legally separate frm the assets f: The derivative dealer; The clearing huse; Anther client f the derivative dealer. T achieve full segregatin at reasnable cst, t be brne by the client if necessary; T recgnise that nt all clearing huses are credit institutins and thus are nt able t hld client assets themselves. Sufficient flexibility shuld be given t allw the parties t make use f whichever structures r arrangements are cnvenient and cst effective (including the use f third party custdians) t achieve the gals f basic segregatin r full segregatin; Whichever mdel is used, segregatin f client cllateral shuld be recgnised and retain its prtectin frm prvisin in: Cnflicting natinal inslvency law; The financial cllateral directive; The default waterfall f the clearing huse (Article 42); Fr the segregatin structures and the resulting csts that are t be brne by clients t be made clear t the client prir t trading; T prvide that segregatin shuld allw, within a shrt time-frame, n the inslvency f the derivatives dealer, fr either: Transfer f the assets and psitin t a secnd derivatives dealer ( prting ); r Clse ut f the psitin and the return f all client assets separately held; T recgnise that under basic segregatin, as well as duble default risk, clients face risk f having t prvide additinal margin resulting frm a deteriratin f the value f assets prvided. Such additinal margin 9

10 wuld be required pr rata between the clients. Margin shuld therefre be sufficiently high quality t prevent deteriratin during stressed market cnditins, e.g. cash r gvernment securities. Similar basic segregatin shuld be prvided t derivative dealers segregating: the clearing huse s assets frm thse f the derivatives dealers; the derivative dealer s assets frm thse f ther derivative dealers. Where clearing members cllect margin frm clients and they pay margin t the CCP, the payment f margin t the CCP shuld ideally be paid and segregated n a grss basis (i.e. nt ffset and reduced amng the client psitins). Where margin is paid t the CCP n a net basis by the clearing member, the client s margin shuld remain segregated n a grss basis at the level f the clearing member (i.e. net margin and any surplus). Benefits f Segregatin Successful implementatin f segregatin prvisins will allw: easy and fast prting f psitin n derivative dealer inslvency; prtectin f client psitins, meaning they are less like t pull trades frm dealers in stressed market cnditins; clients, which are answerable t their sharehlders r investrs, will have mre cnfidence in retaining the value f their cllateral; equal prtectin t that currently available in the uncleared OTC derivatives market; increased cnfidence fr clients in the OTC derivative markets, encuraging greater participatin in the markets. Cst implicatins Under existing mdels where clients assets are pled and may be reinvested by the derivative dealer, the derivative dealer is able t make prfitable use f the cllateral prvided and is thus, in sme cases, willing t ffer reduced clearing fees t clients r demand less cllateral than they therwise wuld. One f the main arguments against intrducing rbust clearing requirements is n the grunds f cst fr bth the derivative dealer and the client. Csts are admittedly expected t be greater than under unsegregated mdels due t: inability f the derivative dealer t rehypthecate assets prvided as cllateral; the administrative cst f perating multiple client accunts; and the remval f cllateral as a resurce in the clearing huse s default waterfall. Hwever, n independent cst analysis has been cnducted n hw much segregatin and, in particular, full segregatin will cst fr the buyside and the derivative dealers are unable t estimate their csts until a clear legislative framewrk is in place. Sme parties have estimated that the increased csts will be t great, such that derivative dealers will be unwilling t ffer full segregatin and clients will be unable t affrd the cst if it is ffered. We believe that the csts are generally ver-estimated and d nt cnsider the limited risk f duble default causing the clearing huse t require the use f client margin. Full segregatin in single, client-specific accunts is pssible and administratively wrkable in the uncleared derivatives market at relatively lw cst fr the buyside and we believe this wuld als be pssible fr the cleared market. Making segregatin mandatry r at least a viable ptin will increase its use, and we believe that clearing huses and derivative dealers will be able t benefit frm ecnmies f scale frm the increased vlumes. A flexible framewrk n the mdels which may be used fr segregatin is als hped t prvide a cmpetitive and innvative market where firms cmpete n 10

11 bth prices and level f service t the client. The lss f the right t reinvest cllateral is expected t be ff-set in mst cases by bth increased numbers f trades being demanded by the buyside (and thus increased clearing fees), and favurable capital treatment where the derivative dealer s cunterparty is the clearing huse. Full segregatin is likely t be affrdable fr many, and clients wh demand this mdel are willing t pay a reasnable cst t gain this extra prtectin. January 2011 (AIMA)