EUROPEAN COMMISSION PUBLIC CONSULTATION ON DERIVATIVES AND MARKET INFRASTRUCTURES. Banque de France s answer * * *

EUROPEAN COMMISSION PUBLIC CONSULTATION ON DERIVATIVES AND MARKET INFRASTRUCTURES Banque de France s answer General comments * * * Banque de France wishes to welcome the opportunity provided by the European Commission to comment on this consultation paper on derivatives and markets infrastructures. As a preliminary comment, Banque de France would like to underscore the paramount importance of the three following issues which need to be taken into account by the forthcoming legislation. CCPs should be granted a limited purpose bank status. First, a limited purpose bank status would contribute in increasing CCPs liquidity resilience by facilitating their routine access to central bank facilities One lesson of the financial crisis is the need for CCPs to have an adequate access to central bank facilities. This is increasingly ascertained by market players. The access to the deposit facility is key to mitigate the investment risk at stake in a turmoil situation, when the market volatility leads the CCP to collect a higher amount of margins whereas the range of eligible counterparties to place its liquidity is decreasing. The access to intraday credit and to the marginal lending facility / discount window is also critical to ease the management of a default when the credit lines from liquidity providers in commercial bank money may not be available. In addition, the collateral may not be easy to liquidate timely, especially in case of a major disruption of the market. In this context, the access to central bank facilities is key for the resilience of the CCP and therefore from a financial stability point of view. The lack of a common and harmonized status for CCPs in the EU is currently a major obstacle for a common framework applying to the access of CCPs to central bank facilities. The access to central bank facilities is a decision that fully falls within the scope of central banks policies and this shall not be imposed by the future European legislation. However, in creating a harmonized status and supervisory framework for CCPs in the EU, encompassing inter 1

alia the criteria required to become eligible counterpart to central bank facilities, the EMIL legislation would facilitate the central bank decision to give access to its central bank facilities to CCPs established in its jurisdiction. The access to central bank facilities can be granted only to CCPs fulfilling the regular conditions laid down by the competent central bank. As a minimum requirement, it is considered that the CCPs should be financially sound, subject to a harmonized supervisory regime, be in a position to submit eligible collateral, subject to minimum reserves and to statistical reporting requirements. The easiest way to fulfill these conditions is today to be licensed as a credit institution which would be achieved through a limited purpose bank status applying to CCPs. Second, prudential requirements associated with a limited purpose bank status would be complementary to EU and international risk management recommendations applicable to CCPs (see annex). The fulfillment of the quantitative and qualitative requirements is ensured by the banking supervisor s control, achieved through a combination of documentation assessment and on-site examination, depending on each Member states practices. The supervisor is entitled to notify caveats and deliver injunctions, nominate a temporary administrator, and sanction compliance failures. Convergence should be ensured between the content of European CCPs risk management standards and international standards, in order to avoid regulatory unlevel playing field between international infrastructures and regulatory arbitrage of market players. Although Banque de France agrees that the principle regarding the need for sound risk management policies should be based in the level 1 text, we have strong doubts about the opportunity to include detailed risk management requirements in the future legislative instrument. They should preferably be referred to level 2 measures which would provide more flexibility to adapt the content of these rules to the evolution of risks generated by CCP clearing activity, as well as the likely changes of international standards which are currently being reviewed by the CPSS and the IOSCO, in close coordination with the Basel Committee The role of central banks vis-à-vis financial markets infrastructures should be duly acknowledged by future legislation. Central banks have legitimate interest in being strongly involved in the regulation of financial markets infrastructures. First, their role in the field of financial stability justifies their keen interest in the smooth functioning of financial markets which requires that adequate infrastructures are in place. This implies as well the need for central banks to perform an effective oversight of these infrastructures to ensure their efficient and smooth operation. Second, from a monetary stability point of view, financial infrastructures have strong interdependencies with interbank payment systems in central bank money, as well as with the implementation of central banks facilities. In general, close coordination between securities regulators, banking supervisors and central banks as overseers is needed to avoid double regulation and loopholes. More specifically, Banque de France considers that the role of the central banks should be explicitly reflected and spelled out in the following regards: First, the determination of eligibility for the clearing obligation should be carried out by ESMA in co-operation with the ESCB. Second, the 2

setting of any technical standards and requirements for CCPs and Trade Repositories (TRs) by a Union body should be conducted in close co-operation with the ESCB. Third, central banks should be prominently involved both in the authorization and ongoing supervision of CCPs. Finally, in view of relations with third countries, Banque de France considers that the decision to recognize third country CCPs should not be taken by the Commission alone, but in close cooperation with the central banks in order to ensure that any central bank concerns and policies for instance on liquidity and risk management, oversight, and location are adequately reflected. Detailed answers to the consultation * * * I. CLEARING AND RISK MITIGATION OF OTC DERIVATIVES What are stakeholders' views on the clearing obligation, the process to determine the eligibility of OTC derivate contracts for mandatory clearing, and its application? Do stakeholders agree that access from trading venues to CCPs clearing eligible contracts should be guaranteed? Process to determine the eligibility of OTC derivatives contracts Banque de France welcomes the proposals made by the Commission. There are indeed strong complementarities between the bottom-up and the top-down approaches. Whilst the first one enables to take into account the technical, financial and risk management capability of a CCP to clear a new asset class, the latter provide the authorities with the possibility to address possible markets failures to provide adequate clearing solutions for markets which risks features require the implementation of mandatory clearing. Moreover, in view of their statutory roles and responsibilities for financial stability, we would like to insist on the need to closely associate central banks with ESMA in the decision-making process for the definition of products eligible to clearing obligation.. Access from trading venues to CCPs clearing eligible contracts Banque de France acknowledges that to give full effect to the clearing obligation, market players should have access to clearing services. However, this should not lead to relax CCPs admission criteria, which are the first layer of risk management. In any case, only regulated entities with sufficient financial and operational capabilities should be accepted as direct clearing members. Access to clearing services for other entities should be implemented through a tiering arrangement. The enhancement of requirements on segregation and portability proposed by the European Commission would be critical for the entities which do not fulfill these access criteria. Banque de France agrees with the objective to avoid discriminatory practices in the access of trading venues to CCPs clearing eligible contracts. However, this objective should not prejudice to the safety of the CCP. Therefore, the legislation should enable CCPs to refuse the access of trading venues based on risk management concerns. 3

Do stakeholders share the general approach set out above on the application of the clearing obligation to non-financial counterparties that meet certain thresholds? Banque de France supports the objectives pursued by the European Commission regarding nonfinancial undertakings. There is indeed a need to mitigate in an adequate way counterparty risk generated by non-financial undertakings performing regular trading activity without discouraging hedging practices by non-financial undertakings. To that purpose, the two thresholds approach proposed by the European commission seems appropriate. The definition of these thresholds should be developed in cooperation with the ESCB. In addition, given the specificities of central banks activities, Banque de France is of the opinion that they should be excluded from the scope of the future legislation on market infrastructures and, in particular, from the clearing obligation. Do stakeholders share the principle and requirements set out above on the risk mitigation techniques for bilateral OTC derivative contracts? Banque de France considers that a general clearing obligation needs to be complemented by adequate regulation for bilaterally cleared trades. There should be clear incentives for trades to be centrally cleared via CCPs, in particular through higher capital requirements for bilaterally cleared trades as foreseen in the consultative document Strengthening the resilience of the banking sector of December 2009 by the Basel Committee on Banking Supervision ( Basel III ) and as scheduled in forthcoming changes to the Capital Requirements Directive ( CRD IV ). While in principle bilaterally cleared trades should be subject to bank risk management practices that are as closely as possible modelled to those of licensed CCPs, full consistency may neither be fully achievable, nor desirable in all cases. The CRD and the Basel II capital framework already provide incentives for banks to collateralise credit, but the provision of such collateral is generally not a precondition for granting credit or for a certain type of credit. Banks should therefore continue to be able to consider the credit worthiness of their counterparties. They should also be able to take a proportionate approach with smaller, non-financial clients that may not have sufficient liquidity or credit facilities in place to make daily variation payments. It is important that the access of these clients to the derivatives market is not impeded by market regulation. II. REQUIREMENTS FOR CENTRAL COUNTERPARTIES As a general comment, Banque de France wants to insist on the fact that the level of details of the requirements which could be included in the forthcoming legislation does not strike a right balance between the objective to reach a sufficient harmonization of the rules applicable to CCPs and the need to ensure the adaptability of these requirements to the evolutions of CCPs activities. From a general point of view, this generates a strong risk to introduce lack of flexibility in the forthcoming legislation, by preventing a future adaptation of risk management requirements applicable to CCPs to take into account the changes in their business risks profiles. Moreover, in the short run, there is a tangible risk of inconsistency between the EU legislation and CPSS-IOSCO recommendations for CCPs currently under review. Therefore, as already mentioned in our general comments on the consultation, Banque de France expresses a strong preference for leaving to level 2 measures the definition of detailed requirements applicable to risk management. 4

Moreover, given the key-role played by central banks in the oversight of CCPs, the setting of any technical standards and requirements for CCPs and TRs by a Union body should be conducted in close co-operation with the ESCB. Finally, the Commission s proposal is missing an important requirement that has to be considered. Banque de France supports that CCPs shall be granted a statute of limited purpose bank as the best means to ensure their robustness with adequate capital requirements and facilitate their access to central bank facilities. Do stakeholders share the general approach set out above on organizational requirements for CCPs? In particular comments are sought on the role and function of the Risk Committee; whether the governance arrangements and the specific requirements are sufficient to prevent and manage potential conflicts of interest; stringent outsourcing requirements; and participation and transparency requirements? Do stakeholders consider that possible conflicts of interests would justify specific rules on the ownership of CCPs? If so, which kind of rules? General approach set out on organizational requirements for CCPs : Banque de France supports the proposal of the Commission, with respect to the organizational requirements applicable to CCPs, subject to some additional provisions and to some comments on the specific items listed below. First, Banque de France has the following comments concerning the requirements which are listed at the beginning of the paragraph Organisational requirements : the reference to adequate policies and procedures could be usefully complemented with a specific statement that CCPs should have an adequate procedure in place in the field of internal control. Banque de France also considers that the following organisational requirements should be added in the legislation: a CCP shall be requested to establish operating rules, whose minimal contents would be established in coordination with ESCB, and shall publish them following their approval by the competent authorities. The role and function of the Risk Committee, governance arrangements and requirements to prevent and manage potential conflicts of interest Banque de France concurs on the importance of a proper mitigation of conflicts of interest in the governance of CCPs, and notably in the organization of the risk committee which is a key element of appropriate governance of CCPs. However, we think that the consultation too much emphasize on the relevance of those potential risks for users-owned-users-governed CCPs. In our view, other forms of corporate structures generate potential risks of conflicts of interests which should not be underestimated. As rightly mentioned by the European Commission, a particular attention should be paid as well to relationships with parent undertakings and subsidiaries, notably when they performed other types of markets infrastructures activities.. In addition, the legislation proposes that the Risk Committee be composed only of representatives of the clearing members and independent administrators. It seems difficult to discard the participation to the Risk Committee of senior executives of the CCP, with a direct responsibility on risk management, in order to benefit from their expertise. The sentence The advice of the Risk 5

Committee should be independent from any direct influence by the management of the CCP should thus be rephrased to be coherent with this requirement. Outsourcing requirements Banque de France agrees with the approach proposed by the European Commission. However, we are of the view that the requirements on outsourcing should be addressed to CCPs rather than authorities. In addition, we further suggest that a provision be introduced which would prevent the CCP from outsourcing certain core functions such as risk management as follows: A CCP shall not outsource critical functions and in particular shall not outsource the risk management function.. Participation and transparency requirements Banque de France agrees with the approach proposed by the European Commission. Do stakeholders share the approach set out above on segregation and portability? Banque de France agrees with the approach proposed by the European Commission. However, we would advocate adding the following requirements in the legislation: - the legislation should state that the clearing members are liable for the effective segregation of the positions and assets of their clients in their accounts, as well as in the account structure of the CCP; - the legislation should also state that a CCP shall provide the possibility to clearing members to segregate their clients positions and assets on a client-by-client basis in the CCP accounts. - in a default situation, the CCP should aim at transferring clients positions on a best efforts basis. Insofar as the possibility to transfer clients-positions depends in last resort on the acceptance of these positions by a non-defaulting clearing member, the CCP should not be bound by an obligation to achieve this given result ( obligation de résultat ). Do stakeholders share the general approach set out above on prudential requirements for CCPs? In particular: what should be the adequate level of initial capital? Are exposures of CCPs appropriately measured and managed? Should the default fund be mandatory and what risks should it cover? Should the rank of the different lines of defence of a CCP be specified? Will the collateral requirements and investment policy ensure that CCPs will not be exposed to external risks? Will the provisions ensure the correct management of a default situation? Are the provisions above sufficient to ensure access to central bank liquidity without compromising central banks' independence? Do stakeholders share the general approach set out above on prudential requirements for CCPs? Banque de France welcomes in principle the objective of the Commission to raise the bar as regards prudential requirements applicable to CCPs. However, as already said, it is crucial that the future legislation leaves to level 2 measures the specification of detailed prudential requirements. 6

Moreover, granting CCPs with a limited purpose bank status would facilitate the definition of prudential requirements. The adaptation of prudential rules of credit institutions to CCPs gives a useful guideline on the own capital requirements of CCPs. Actually, the banking regulation addresses very accurately risks that are not covered by the margins and clearing funds collected by the CCP, e.g. the investment risk. Banque de France would like to stress this status should be a limited purpose bank status (and not a general credit institution status) as a CCP is not taking risks for its own account and shall be prohibited from entering into other risk-taking activities and as the banking status and the calculation of capital requirements need to be adapted to the specific patterns of CCPs. However, the limited purpose bank status avoids building from scratch and is the best source of inspiration to address quickly and adequately these issues. In addition, a banking status ensures an adequate access of CCPs to central bank facilities. One lesson of the financial crisis is the need for CCPs to have an adequate access to central bank facilities. This is increasingly ascertained by market players, including CCP12 1. Access to the central bank deposit facility is key to mitigate the investment risk at stake in a turmoil situation, when the market volatility leads the CCP to collect a higher amount of margins whereas the range of eligible counterparties to place its liquidity is decreasing. Access to intraday credit and to the marginal lending facility / discount window is also critical to ease the management of a default when the credit lines from liquidity providers in commercial bank money may not be available. These facilities are key for the resilience of the CCP, and therefore from a financial stability point of view. The benefit of a limited purpose bank status is the easiest way for CCPs to get standard access to central bank facilities, while avoiding stigma and moral hazard effects linked to an ad hoc emergency facility. What should be the adequate level of initial capital? The definition of the risks covered by the capital of the CCP needs to be significantly complemented. When defining CCPs minimum capital requirements, one must take into account the existence of specific financial buffers implemented by the CCP to mitigate the counterparty risk it bears on its clearing members (i.e. mainly margins and clearing funds). As a consequence, the capital of the CCP should in principle cover all those risks generated by the general business of the CCP which are not already covered by the specific financial buffers mentioned above. This notably includes business risk, operational risk, settlement risk, and investment risk. Moreover, the implementation of these minimum capital requirements will necessitate entering in a much higher level of details regarding the definition of the types of assets forming the core capital of the CCP for instance. To that purpose, the legislation should refer to level 2 measures defined by ESMA in close cooperation with the ESCB and with the active involvement of the EBA which is well placed to address this type of issues. As a minimum requirement, initial capital for CCPs should not be lower than minimum capital for credit institutions, i.e. 5 million euros. Are exposures of CCPs appropriately measured and managed? Banque de France is supportive of the approach requiring CCPs to measure exposures to their participants on a near real time basis. The frequent adaptation of CCPs financial resources is notably of key importance in stressed periods when price volatility can be subject to significant shift on an intraday basis. In this respect, the drafting of the proposed text presents some inconsistencies. Whilst the principle of an intraday update of positions and margins collections is mentioned, one 1 CCP12 is the global association of central counterparties 7

concludes that a CCP [should] fully collateralize its exposures with all its clearing members, and, where relevant, CCPs which have interoperable arrangements, at least on a daily basis. It would seem more coherent to set as a minimum requirement the fact that a CCP should fully collateralize its exposures at least on a daily basis and to add another requirement concerning the fact that the CCP should have the operational capacity to call routinely for additional collateral on an intra-day basis. The conditions in which such calls would be compulsory could be specified in level 2 measures. Another inconsistency lies with fact that it is proposed to fix the confidence interval of 99% in the level one legislation while the time horizon is only qualified as appropriate and left to level 2 or 3 measures. It is not adequate to have in such a level of precision and details in Level 1 legislation since the best practices may evolve over time and we suggest leaving both targeted figures (confidence interval and time period) for technical standards to be set by ESMA with the cooperation of the ESCB. Last, a general reference is made to the obligation of segregation of the margins posted by each clearing member. We would suggest including this reference, as well as the other possible requirements on segregation, in a single part on segregation requirements. Should the default fund be mandatory and what risks should it cover? In accordance with the current international standards for CCPs and EU CCPs practices, the clearing fund should be calibrated to cover, at a minimum, the default of the clearing member to which the CCP has the biggest exposure, in extreme but plausible market conditions. The proposed legislation, in the part on other risk controls, proposes to calibrate the default fund in order to cover the default of the clearing member to which it has the largest exposures or of the second and third largest clearing members, if the sum of their exposures is larger. Although Banque de France agrees with the objective to enhance prudential requirements, it would recommend that the specific item concerning the number of defaulting clearing members to cover should be shifted to Level 2 legislation. Such an approach would allow for an in-depth impact analysis of this measure and for efforts to ensure convergence with forthcoming international standards on this issue to be made. It would also allow more flexibility for specific derivatives (e.g. single-name CDS where the simultaneous default of a clearing member and of a non-clearing member might lead to losses much higher than the default of the second and third largest clearing members). This would also avoid regulatory arbitrage between CCPs of the different regions of the world and ensure level playing field and equal treatment, by allowing to design level 2 measures after the international standards and the main pieces of legislations in the other parts of the world have been finalised. Also, for purposes of clarity, we would suggest merging all the requirements concerning the clearing funds in the part of the legislation dedicated to this item, i.e. D and E, in the consultative document. Banque de France considers that a default fund (or more, as deemed necessary by the competent authorities, depending on the classes of instruments cleared by the CCP) should be mandatory. Should the rank of the different lines of defense of a CCP be specified? Banque de France sees no need to specify in details the rank of the lines of defense, insofar as different models of organizations insofar are conceivable with their pros and cons. Actually, the requirement for a CCP to draw on its own funds before the contributions of non-defaulting clearing members in the clearing fund is a possible option. However, it would lead to a major change on the 8

current risk management framework of most CCPs. We believe that the ordering of the resources in the default waterfall should be left to Level 2 measures, following a careful impact analysis. For sake of consistency if the setting-up of clearing funds is made mandatory, it will be necessary to specify that the clearing fund can be activated only when individual margins posted by the defaulting member have been exhausted. This requirement is aimed at mitigating the moral hazard inherent to a risk mutualisation scheme, such as a clearing fund. Besides, we would like to point out that the consultation is mainly focused on credit risk and does not devote sufficient analysis to liquidity risk. The list of resources that may be used is not prioritized and comprises items with a very different quality and liquidity. More generally, the proposal is very much focused on credit risk but very vague and poor regarding liquidity risk, which is clearly THE risk for which it is key to make strong proposals and to fully draw on the lessons of the crisis. The need to ensure efficient liquidity risk management by CCPs is clearly one major reason to require CCPs to be licensed as limited purpose banks. One of the main conditions to access to central bank s facilities is indeed to hold a banking license. If CCPs were being licensed as limited purpose banks, this would facilitate the fulfillment of the standard conditions to access central bank standing facilities. This access to central bank credit operations in the currency in which the cleared products are denominated may make a considerable difference regarding the soundness of the liquidity management of the CCP. In times of money markets distress, commercial bank extended credit lines may be unreliable sources of liquidity since banks may not be sufficiently liquid themselves to maintain these credit lines. Access by CCPs to central bank standing facilities would contribute to overcome the major drawbacks of the proposal made in the consultation paper to prohibit clearing members from providing credit lines to the CCP above 10% of the credit lines needed by the CCP. Its implementation could be difficult in practice. First, it is difficult for the CCP to anticipate its liquidity needs ex ante. Only banking groups of a significant size can grant credit lines to a CCP. It is very likely that these groups are also clearing members of most of the CCPs. If the new requirement were to be applied, these banking groups could have to cut all or part of existing credit lines, leaving CCPs without access to liquidity. A more realistic rule would be to specify the need for CCPs to calibrate their liquidity waterfall in level 2 technical measures. Will the collateral requirements and investment policy ensure that CCPs will not be exposed to external risks? Whilst we overall agree with the proposed approached, the draft legislation is silent about a major issue which is to ensure a homogeneous level of protection and enforceability of the CCPs collateral arrangements throughout the EU by an adequate and harmonized legal basis. While Banque de France agrees that access to central banks deposit facility under the conditions defined by each central bank can be a useful tool for CCPs liquidity management, notably in times of money markets distress, the proposal of making the use of this facility, where available, mandatory may have potential negative economic impact on CCPs which draw revenues from spreads between remunerations provided to collateral givers and remuneration received by the CCP. The use of the deposit facility should better be left to the CCP discretion based on its assessment of the money market conditions. 9

Are the provisions above sufficient to ensure access to central bank liquidity without compromising central banks' independence? As regards the provision of central bank facilities, Banque de France would like to recall as a general observation that any regulation must fully respect the independence of central banks. Central bank facilities are a crucial tool for market infrastructures in view of their liquidity and risk management. However, central bank facilities are not designed per se to meet the business needs that market infrastructures may have, and it remains for each central bank to determine independently what facilities it wishes to offer to central counterparties and other market infrastructures. In this respect, Banque de France notes that one of the main conditions to access central bank facilities is to be licensed as a credit institution. Granting CCPs with a limited purpose bank status would highly facilitate their access to central bank s facilities. Do stakeholders share the general approach set out above on the recognition of third country CCPs? Are the suggested criteria sufficient? Do stakeholders consider that additional criteria should be considered? Do stakeholders agree with the extension of the clearing obligation to contracts cleared by third country CCPs to ensure global consistency? In accordance with Eurosystem s location policy, Banque de France considers that CCPs clearing euro-denominated products reaching a systemic importance for the euro area should be located within the euro area, in order to have a direct oversight of the Eurosystem over these CCPs enabling to grant them access to central banks facilities and ensure they do not weaken Eurosystem s control over the euro. In this perspective, Banque de France considers that the decision to recognise third country CCPs should not be taken by the Commission alone, but in close cooperation with the central banks of issue of the currencies cleared by this CCP (if services are provided in a currency of the EU), vesting them with the competence to prior consent to their authorization. III. INTEROPERABILITY Stakeholders' views are welcomed on the general approach set out above on interoperability and the principles and requirements on managing risks and approval. Banque de France would like to stress that the promotion of interoperability is not the main objective of this legislation the purpose of which is neither per se to serve the objective of promoting competition between infrastructures. The objective of this legislation is indeed to enhance the robustness of post-trade infrastructures and make them more resilient. Banque de France would then like to point out that interoperability is not a risk mitigating factor, but, on the contrary, a factor that will increase systemic risk and put financial stability into question. Links among CCPs generate significant risks which need to be carefully managed. Links imply additional interdependencies generating increased contagion vehicles over CCPs. One should think about how the Lehman Brothers failure would have been managed in a context of a spaghetti network of linked CCPs, with potentially unclear 10

responsibilities and commitments, possible re-hypothecation of collateral leading to conflicts of use, the impact of different legal frameworks surrounding the segregation and portability. Therefore, while Banque de France still has strong doubts on the opportunity to include provisions on interoperability in this legislation, we welcome at least that the proposed approach by the European Commission puts a real emphasis on risk management issues, and that the definition of interoperability provided in annex I is neutral in this regard interoperability' means two or more CCPs entering into an arrangement with one another that involves cross-system execution of transactions. Besides, Banque de France would like to make the following comments regarding risk management requirements applicable to interoperability arrangements : - the legislation indicates that the default of a clearing member of one CCP should not affect an interoperable CCP. One of the situations in which this may happen is if a CCP (CCP1) contributes to the default fund of the other CCP (CCP2). In this case, the contribution of CCP1 may be used if a member of CCP2 defaults, meaning that CCP1 can be affected by the default of a member of CCP2. Banque de France, therefore, recommends that the legislation explicitly state that a CCP should not contribute to the default fund of another CCP, should such default fund be mutualized with clearing members; - the proposal made by the European Commission stands as follow If the risk management models used by the CCPs to cover their exposure to their clearing members as well as their reciprocal exposures are different, the CCPs would need to identify them, assess risks that may rise and take measures, including additional financial resources, that limit their impact on the interoperability arrangement as well as their potential consequences in terms of contagion risks and ensure that these differences do not affect each CCP's ability to manage the consequences of the default of a clearing member. This proposal seems particularly risky as this would lead in practice to rely on the less ambitious risk management model: therefore this provision should be replaced by a stringent obligation for two interlinked CCPs to adopt a fully harmonized methodology of risk calculations before establishing a link. This would also avoid a race to the bottom, i.e. an enhanced competitive advantage for CCPs that would implement the less stringent risk management procedures. - finally, Banque de France would like to stress that interoperability arrangements, if any, would need to be subject to a strict approval procedure by relevant authorities, that could be defined in Level 2 legislation. The national competent authorities as overseers and supervisors should in any case remain competent for the assessment of the links to be established between their domestic CCPs. IV. REPORTING OBLIGATION AND REQUIREMENTS FOR TRADE REPOSITORIES What are stakeholders' preferred options on the reporting obligation and on how to ensure regulators' access to information with trade repositories? Please explain. The recent development of Trade repositories in the field of post-trading infrastructures for OTC derivatives highlights the need to have the highest possible level of clarity on the context and the objectives underlying the regulatory push for the establishment of trade repositories. Banque de France considers that one of the overarching objectives of trade repositories is to provide competent authorities (i.e. securities regulators, banking supervisors and central banks) with swift and 11

unfettered access to comprehensive and consolidated information stored in trade repositories, including data presently covered by professional secrecy, in order to identify potential sources of market instability and concentration risk, assess the risks in the books of regulated institutions, to monitor the extension of CCP clearing to OTC derivatives and to supervise market integrity. Banque de France notes that the Commission proposes to mandate ESMA to draft technical standards to determine the reports to be made by market participants to TRs for the different classes of derivatives. In view of the objectives of TRs to fulfill a wide range of authorities needs, Banque de France considers that the determination of such technical standards should not be carried out by the ESMA alone, but in cooperation with the ESCB. Regarding registration of TRs, Banque de France considers that the definition of the regulatory regime for trade repositories located outside the EU is a key issue to be addressed by the future legislation. Banque de France considers that a main benefit of option 2 (recognition of third country trade repositories) would be to facilitate an access to consolidated data through a single access point, which in a crisis situation is an important feature. However, at this stage, several aspects make such an option questionable. Primarily, it is not ascertained that the need for unfettered access by relevant EU authorities to information stored by TRs located in a third country would be fulfilled. Under several jurisdictions, legal provisions relating to professional secrecy may prohibit the reporting by dealers to trade repositories in third countries of data relating to trades concluded by their clients. Therefore, the relations with third countries raise not only issues in terms of access to data by relevant authorities but also regarding the reporting obligation. Furthermore, the ability for EU authorities to use the information received directly from a trade repository in a third country in possible legal proceedings should be taken into account. In addition, recognition of third countries TRs would be useful only (i) to the extent that the model of a single global TR by asset class would prove to be prevalent, (ii) in case the single TR would be located outside the EU. However, these conditions could not be ascertained in any case, because public authorities cannot impose a private monopoly and we are aware that several jurisdictions in the world have started to impose by law the set-up of a local TR. Finally, an additional and important aspect in view of the functions of public interest performed by trade repositories, is that the organization of their governance must guarantee that the interests of all stakeholders, including interested authorities, are duly taken into account. The current implementation of trade repositories seems to be heading for single global trade repositories by asset classes, but it is not ascertained that these infrastructures will be able to collect and share information in ways that are useful to all the relevant authorities. The designation process for existing trade repositories is indeed far from having given a say to all interested authorities as is demonstrated, for instance, by the fact that the information needs to address market integrity issues are often not considered. At best, this has been done through a very opaque procedure coordinated by the International Swaps and Dealers Association whilst, at worst, some infrastructures like CLS have gone through a self-claiming process for the designation of a trade repository on FX products. Based on the above-mentioned considerations, option 1 (trade repositories located in the EU) could be considered as a natural fallback option. The establishment of trade repositories, possibly through subsidiaries, in the EU is clearly better suited to achieve the goal of unfettered access by European authorities, while overcoming the other mentioned legal impediments. The technical drawbacks 12

generated by this option must not be overestimated. Potential diverging reporting requirements and formats can be easily solved through an efficient cooperation for their harmonization between the interested authorities. But access to consolidated data would remain impossible until legal barriers would have been lifted However, option 1 would present a common weakness with option 2, which is the governance issue and designation process. If effective measures to address governance and designation process are not enforced, only option 3 would reasonably achieve objectives expected from a TR. Indeed a public utility status would be the most clear-cut way to put a TR economic, legal, governance status in conformity with its public function, which is to provide competent authorities with swift and unfettered access to comprehensive and consolidated information stored in trade repositories. Do stakeholders share the general approach set out above on the requirements for trade repositories? In particular, are the specific requirements on operational reliability, safeguarding and recording and transparency and data availability sufficient to ensure the adequate function of trade repositories and the adequate protection of the data recorded? Trade repositories will play a systemic role in ensuring transparency of OTC derivatives markets to regulatory authorities which involves the definition of an appropriate authorization and supervision framework relying on adequate risk management rules in order to: - ensure that entities subject to reporting requirements can perform this duty in cooperation with infrastructures offering sufficient conditions of safety and efficiency; - provide authorities with sufficient confidence in the quality of data collected from trade repositories to perform their mission. Banque de France agrees with the overall level of granularity of the requirements for TRs and stresses that provisions on risk management defined for trade repositories in the future legislation should take into account the work led by CPSS-IOSCO, which has recently published for consultation considerations for trade repositories. In addition, most trade repositories are likely to extend their business beyond their core activity of registration, proposing to their clients bundled services such as portfolio reconciliation, matching, connection with settlement services providers like CLS. The future legislation should carefully take into account this possible evolution of trade repositories business in stating for competition and efficiency reasons, the principle that services provided by trade repositories should be unbundled, and making sure that the licensing and on-going supervision of trade repositories encompass the full scope of provided services. V. TECHNICAL REFERENCE GLOSSARY OF DEFINITIONS Do stakeholders agree with the definitions set out above? Banque de France would like to share a few remarks with the Commission regarding the definitions. The first concerns the definition of market infrastructure which includes central counterparties and trade repositories. In light of the forthcoming text, we suggest that central securities depositories also be included as a market infrastructure. 13

The second remark concerns the definition of clearing. Although we agree that clearing means the process of establishing settlement position, including the calculation of net positions, we do not agree that clearing includes the process of checking that financial instruments, cash or both are available to secure the exposures arising from a transaction as this process is part of the settlement of a transaction. We suggest using the definition found in the glossaries published by the Bank for International Settlements and by the European Central Bank which provide as following 2 : The process of transmitting, reconciling and, in some cases, confirming payment or securities transfer orders prior to settlement, possibly including the netting of orders and the establishment of final positions for settlement. Sometimes the term is used (imprecisely) to include settlement. 2 http://www.ecb.int/paym/cons/shared/files/glossarypaymentclearingsettlementsystems.pdf?ad054cd263feaff 3f03b49c4e31e59e0 http://www.bis.org/publ/cpss00b.pdf 14

Annex: Prudential requirements applicable to a CCP vested wit a limited purpose bank status This annex is based on the framework applicable to CCPs established in France which must hold a banking licence pursuant to French law (article L. 440-1 of the Monetary and Financial Code). As a limited purpose bank, a CCP would have to comply with the following quantitative rules laid down by directive 2006/48/EC: - The initial capital (comprising capital and reserves) must be over EUR 5 million (directive 2006/48/EC, art. 9); - Its own funds may not fall under the initial capital required (directive 2006/48/EC, art.10); - Own funds requirements ensure that instruments eligible as own funds are precisely defined (directive 2006/48/EC, art.56 and 57, also taking into account the current review of the own funds definition which is to be strengthened); - The solvency ratio (own funds over risk-weighted exposure amounts) must be at least 8 % (directive 2006/48/EC, art. 75). In the case of a CCP, the existence of a clearing fund must be taken into account, as it comes into play to cover losses before the CCP s own funds are affected. Therefore, there is a need to adapt the calculation of the solvency ratio by dividing the sum of its own funds and the clearing fund by the weighted-risk exposure amounts which encompasses credit risk, market risk and operational risk. Such an adaptation, ie incorporating the clearing fund in the numerator, avoid imposing a double requirement. In addition, supervisory authorities (directive 2006/48/EC, art. 75) within their review process determine whether the arrangements, strategies, processes and mechanisms implemented by the institutions and the own funds held ensure a sound management and coverage of the risks (directive 2006/48/EC, art. 124 and 136), which include notably business risk according to supervisors practice as resulting from discussions within the Basel committee and CEBS. Supervisors can require the institutions to hold own funds in excess of the 8% minimum level if need be (directive 2006/48/EC, art. 124). - Large exposure (exposure to a counterparty in excess of 10 % of the credit institution s own funds as defined in directive 2006/48/EC, art. 111) ratios: a credit institution may not incur a risk exposure to a counterparty totaling over 25 % of its own funds; large exposures in total may not exceed 800 % of its own funds (directive 2006/48/EC, art. 111). This requirement contributes to the CCP achieving a diversification of its investments (margin reinvestment), which does not preclude more stringent internal procedures in order to avoid concentration risk. In addition to quantitative requirements, a CCP under a limited purpose bank status would also be expected to comply with qualitative rules based on directive 2006/48/EC (art. 22) and directive 2004/39/CE (art 13), notably that it must implement an internal control. 15