EMIR: possible solutions for difficulties mandatory clearing

02/11/2021Topic:  Tag CACEIS EMIR

© Olivier Le Moal

Recital 26 of EMIR expressly acknowledged that to avoid the likely negative impact of such a requirement on the retirement income of future pensioners, the clearing obligation should not apply to pension schemes until a suitable technical solution for the posting of non-cash collateral as variation margin had been developed by Central Counterparties to address pension funds' lack of cash for use as collateral.

However, finding a solution that addresses the issues around mandatory clearing and Pension schemes  has taken longer than initially anticipated.

While some of these existing solutions need to be further developed or perhaps studied by regulators, their addition should create the conditions under which pension schemes could centrally clear.

Possible solutions

  • CCPs accepting non cash collateral for variation margin settlement

At first glance this seemed to be the easiest solution but it turned out that here were too many obstacles.

This option assumes that Pension schemes  become direct clearing members and are permitted to post high quality bonds, with an appropriate haircut instead of cash for their variation margin  calls directly to the CCP. But if debt securities were to replace cash, this would result in a number of issues.

The Report recognises that one of the main issues with this option is that, as opposed to cash, which has a stable value, the nominal value of bonds will always be subject to market volatility. This would require developing valuation protocols for posted collateral.

The Report concludes that this option would entail significant operational and legal risk resulting from the fact that variation margin  needs to be passed through daily between counterparties on either side of back-to-back trades, which would leave counterparties with a negative mark-to-market variation margin  with a shortfall in meeting their variation margin obligations to those counterparties that have a positive mark-to-market.

Since this option generated reservations from many stakeholders, CCPs and regulators, it was eventually discarded.

  • Relying on the ancillary services of collateral transformation by clearing members

This option focuses on the collateral transformation services already provided by clearing members to their direct clearing clients. It has the benefit of not requiring pension schemes to increase their cash buffer.

However, this option was also rejected on the grounds that such services would expose clearing members to additional risks and costs, including related capital requirements covering collateral and repo market transactions.

Clearing members are thus more reluctant to extend collateral transformation to variation margin  flows, concerned by the impact on their balance sheet or their capital adequacy requirements – non-cash variation margin is not eligible as risk-reducing in all prudential ratios.

  • The market-based repo solution

This option looks to provide pension schemes with reliable sources of liquidity to fund cash margins, enabling pension schemes to source cash through providers other than CCPs or their clearing member. This might then be possible by turning to the broader market.

While there is market consensus that the repo market is generally in good health and permits collateral transformation and access to liquidity, a significant problem could emerge if the repo market ever becomes unavailable or not deep enough to deal with the pension schemes' liquidity needs for their variation margin. In which case, a pension scheme may not have the liquidity access as and when needed. This issue could also be aggravated by a CCP triggering defaults of those pension schemes unable to provide cash variation margin , thus increasing potential systemic risk.

The Report highlighted that the main challenge is to establish the impact of temporary limitations on access to the repo markets, for example, due to stress events so further analysis will be required to understand whether repo markets would be able to absorb pension schemes liquidity demands in both normal and stressed circumstances. So this option is not discarded right away but needs closer attention.

  • Access to alternative emergency liquidity arrangements

This option considers how a pension scheme subject to the mandatory clearing obligation could access (emergency) liquidity arrangements in order to avoid becoming a source of systemic risk under conditions of market stress.

Since pension schemes have no direct access to liquidity arrangements provided by central banks, this option looks at alternative liquidity arrangements. It remains unclear whether CCPs without a banking licence, which may access only emergency central bank liquidity facilities under certain conditions, can facilitate such emergency arrangements for pension schemes.

CACEIS is a Global player with an international Global Coverage: connection to more than 60 cash and derivative markets, and coverage of 85 countries for asset custody

  • Multi-Asset Class Offering: all futures and options on Equity, Index, Fixed Income, Commodities, etc.
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We offer adapted collateral management services

  • Financing solutions, including transformation of securities collateral into cash collateral via securities lending, REPOs or credit lines
  • Collateral management for both cleared and non-cleared OTC products
  • For non-cleared OTC products, intraday initial margin and daily variation margin management, including FX management. Possibility to open segregated accounts by client/fund in our books for collateralization
  • For cleared OTC products, processing of initial margin and margin calls from CCPs/clearing brokers