In recent weeks, there have been several industry developments including regulatory updates, start dates and delays. Here is our recap from the last few weeks with deeper analysis to be shared in the coming weeks as these developments evolve.
REGULATORY START DATES
SDR starts (minus mandatory buy-ins)!
As of 1 February, the Settlement Discipline Regime (SDR) which makes up the third phase of the Central Securities Depositories Regulation (CSDR), officially kicks off. SDR introduces a set of measures aiming to both prevent and address settlement failures of securities transactions. This new regime also includes reporting and monitoring measures central securities depositories must adopt. What is missing from the 1 February start date is mandatory buy-ins, which have been postponed following an agreement by the European Parliament and Council 24 November 2021 and confirmed in a statement from the European Securities and Markets Authority (ESMA) in December 2021. So, what’s next for firms when it comes to addressing settlement failures?
Daniel Carpenter, head of Regulation at Meritsoft (a Cognizant company) weighs in:
“While banks have implemented a range of solutions to manage CSDR penalties and appeals processes, more needs to be done to achieve the overall reduction in settlement fail rates that the industry aspires to. The focus now needs to be on investing in the systems and processes that allow firms to really understand their settlement fails workflows.
This requires the digitization of high volumes of disparate data, from multiple systems and regions, and across distinct asset classes and clearing houses. This data must be available centrally to allow in-depth analysis of where trades are failing to settle and why. With this insight, banks can take action to reduce their incidence of fails and make informed decisions about which of their counterparty relationships are more, or less, profitable.
By taking a more strategic approach to fails management the more forward-looking banks will be able to look beyond the regulatory imperative to achieve ever-greater efficiencies and cost optimization across their operations.”
SEC’s SBSR went live too
Securities-based swaps reporting (SBSR) is an element of the U.S. Securities and Exchange Commission’s (SEC) Dodd-Frank reporting requirement. On 14 February, Part 43 real-time of SBSR’s Public Price Dissemination (PPD) reporting went live. In addition to backloading trades, firms need to be ready to report the typically anonymized data fields.
Kaizen Reporting’s senior regulatory reporting specialist, Alan McIntyre, explains:
“This is the SEC’s second major milestone in their rollout of Securities-Based Swap Reporting (SBSR). The first was the go-live of Part 45 transaction and valuation reporting in November last year.
“The purpose of Part 43 real-time reporting is to provide transparency on pricing to the market. Firms must report ‘real-time’ pricing data almost immediately upon execution. The actual data that gets publicly disseminated is heavily anonymised but through showing the pricing trends for the various swap instruments, the expectation is that this will provide price transparency to ensure a level playing field. While it’s only a small number of fields, it will be tough for firms as the rules say ‘as soon as practically possible’.
“If that wasn’t enough, firms are expected to backload every expired Security-Based Swap since 2010 before the third and final instalment of the SEC rollout on April 14.
Now that we have covered some key milestones let’s move on to what hasn’t happened.
CFTC re-writes delayed
The Commodity Futures & Trading Commission’s (CFTC) division of data (DOD) issued a no action letter 31 January to officially delay the implementation of their re-write of swap data reporting until later this year.
This extra time is an opportunity for many to conduct more preparation and testing ahead of the new deadline of 5 December 2022. Read on for our commentary “Testing Times Ahead with the CFTC Re-write” on the topic from earlier this month.
DEVELOPMENTS IN THE CCP CLEARING SPACE
Industry developments on EU CCP clearing
Temporary equivalence extended to UK CCPs
The European Commission has extended the time-limited equivalence for UK central counterparties (CCPs) for another three years until 30 June 2025. This announcement follows a statement made by Commissioner for Financial Services, Financial Stability and Capital Markets Union, Mairead McGuiness on the way forward for central clearing where she noted an announcement on an extension of temporary equivalence would be forthcoming.
There will no doubt be more updates to come in this space but in the meantime, Christian Lee, partner at Sionic says:
“I think this is a significant boost to the City and LCH in particular. The risk of market disruption has clearly influenced this decision and the status quo for OTC clearing is being maintained. Nevertheless the concerns major buy and sell side participants have regarding concentration of risk means that alternative EU based solutions will co-exist with LCH.”
Pensions and clearing
Sticking with CCP clearing, a change is afoot for Pension Scheme Arrangements (PSA) following ESMA’s recommendation to the European Commission for the ending of the current exemption from the CCP clearing obligation from 19 June 2023. The current exemption for PSAs applies until 18 June 2022.
Craig Bisson, partner at Simmons & Simmons, shares his views:
“The end of the EMIR clearing exemption would be significant for pension scheme arrangements, including Institutions for Occupational Retirement Provisions (IORPs), which are often big users of the interest rate swaps products that (along with certain index credit default swaps) are subject to mandatory clearing.
It was the reluctance of CCPs to accept non-cash Variation Margin (VM) that led to the exemption. At the CCP level, this has not really changed – and so schemes will need to either ensure they hold the requisite cash – or otherwise that they can use techniques such as sponsored cleared repo to generate this. If pension schemes are forced to clear derivatives, in addition to setting up clearing arrangements to access CCPs, additional lines may need to be set up in parallel for this cash VM element. There may be new risks introduced here.
Pension schemes operating in the Liability Driven Investment (LDI) space, in particular, can take very long-dated positions with broadly directional swap portfolios. Arrangements with clearers to ensure that these can be maintained throughout the lifetime of the intended trade, will be key. The ability to BAU and post-default port, management against clearing limits and the careful calibration of termination rights, will all be important.
ESMA makes no bones of the fact that one of the aims of removing the pension scheme clearing exemption is to reduce reliance on UK CCPs. So yet again we see a political/Brexit angle at work here.”
APC margin measures for CCPs under review
ESMA has launched a consultation paper to review EMIR’s requirements on anti-procyclicality (APC) margin measures for CCPs. The EU securities market regulator seeks input from market participants on the possible review of the EMIR RTS with the intention of harmonising existing CCP APC margin measures and relevant tools. The deadline for the industry to share views on the consultation paper is coming up.
Christian Lee, partner at Sionic, weighs in on this consultation:
“With all risk and margin models there is inevitably a degree of uncertainty due to the unpredictability of markets. EMIR’s anti-procyclicality (APC) have been evolving over the years with the final guidelines being published in 2018. Following the market volatility in March / April 2020 and subsequently it is appropriate for ESMA to be reviewing the performance of the APC tools hence the timing of this consultation paper.
It should be recognised that, by and large, CCP’s performed well during this period of volatility with no defaults being triggered and hence no losses incurred. Nevertheless there were some spikes in margin calls which caused some liquidity strains.
Whilst harmonisation of policies and margin measures is a sensible goal, there is a risk of being overly prescriptive. With all stress events some asset classes will experience greater volatility and hence the perception that some models performed ‘better’ than others during March / April 2020. A different market crisis could result in markedly different performance. Additionally, margin spikes are highly dependent on the degree of concentration within individual portfolios with buyside exposures typically more directional and hence susceptible to large margin moves.
From the existing APC measures there is widespread adoption of the ‘25% buffer’ which scales margin during periods of low volatility. Along with the application of including a 25% weight to stress observations in the lookback period, these tools help to dampen margin volatility. “
“It will be interesting to view the response from participants, but it is unlikely that there will be any significant changes to existing APC tools. Additionally, it is important to recognise that APC models are just one tool available to the CCP, over-reliance on models is a recurring theme in historic market failures. Stress testing, liquidity management and pro-active risk management by the CCP risk team is the key to successfully negotiating a crisis.”
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