In November’s Economic and Monetary Affairs Committee (ECON) meeting, the European Securities and Markets Authority (ESMA) as well as the European Commission (EC) had been pushing for a one year delay for the introduction of Europe’s flagship markets legislation. MiFID II and MiFIR still require plenty of legislative work to be completed as well as building an IT system that underpins the regulatory requirements. In a note from 02 October 2015, ESMA specifies that “[t]he current state of the final rules and the expected publication time prevent the different parties to start working with the necessary certainty and we are already past the point of no return after which the launch of the system into production in January 2017 becomes unfeasible.” The main concerns are around major topics such as reference data, transaction reporting, transparency parameters and publication, and position reporting. Martin Merlin, director of financial markets at the EC, stated at the ECON meeting that a delay to MiFID II may be necessary in order to smooth the implementation process. He would advise to delay the whole package for one year as this would be the simplest approach. Members of the European Parliament (foremost MiFID II rapporteur Markus Ferber) were less than disagreeable to such a notion but have now subsequently indicated that they would back a delayed introduction of the legislation. The most likely scenario for a delay is a Level 1 fix, which means that the implementation date in the original MiFID II legislation will be amended rather than delaying only parts of the package.

MIFID II – A year’s delay of MiFID II seems inevitable ESMA published responses to Consultation Paper on ITS under MiFID II EMIR – Central clearing for Norwegian, Polish and Swedish Interest Rate Swaps proposed Impact of the US Prudential Regulators uncleared OTC margin regulation TARGET2-SECURITIES – Thoughts on the most likely scenario for the Target2-Securities (T2S) migration schedule following Euroclear’s delay Treatment of CVA under SREP

It is very likely that MiFID II and MiFIR will now only enter into force in January 2018. This gives market participants more time to implement the required changes to comply with MiFID II requirements. Financial services firms affected by MiFID II should now take a look at their implementation programmes and assess possibilities to not only become barely compliant but to actually seek opportunity in the new markets rules. We do not recommend stopping activities now but rather keep the pedal to the metal and use the momentum to create a viable business proposition and target operating model that will position the firm for the time after 2018. Market participants should also keep an eye on affiliated regulations such as Packaged Retail and Insurance-based Investment Product (PRIIPs), Product Oversight and Governance Arrangements (POG), Market Abuse Directive / Regulation (MAD/MAR) – as a delay of MiFID II will likely also affect the implementation timelines of these regulations.

On 04 November, ESMA published the responses to its consultation on three Implementing Technical Standards (ITS) under MiFID II which had not been in consultation phase before.

: Standard forms, templates and procedures for the notification process of DRSPs  The proposal that national competent authorities have to designate contact points was appreciated by the respondents.  MiFID II and ITS 2 will enter into force at the same date. As the notification process can last up to six months, one institution was concerned whether there will be an interim solution. : Format and timing of weekly position reports for commodity derivatives, emission allowances and derivatives thereof  Some concerns were raised regarding the quality of the reports – due to both the short time span of only one working day for a trading venue to prepare the reports and the problem that trading venues do not have the information needed especially to classify end clients with respect to the type of activity yet.  Gathering more information from end users is seen critically regarding client confidentiality.  Besides several comments on the reports format, some respondents proposed formulations from the Commodity Futures Trading Commission’s (CFTC) Commitments of Traders (CoT) report.  Another concern was that securitized derivatives which have commodities as an underlying are not exempt from the reporting obligation. They are settled like other securities traded on cash markets and are mainly held by retail investors in positions of small sizes. The implementation of the reporting rules might lead to a retreat of trading venues from that market.

The three ITS cover the suspension of financial instruments from trading on a trading venue, the notification process for data reporting services providers (DRSPs) and the weekly aggregated position reports for commodity derivatives, emission allowances and derivatives thereof.

The consultation was the last opportunity for financial institutions to influence the final ITS. ESMA will now revise its drafts. The final ITS will be sent to the EC for endorsement by 03 January 2016. All three discussed ITS will enter into force together with MiFID II in early 2017, pending on the decision of a postponement of MiFID II.

All in all, ESMA published 12 responses on its website, mainly stemming from different European regulated markets, exchanges and trade systems but also from two German banks. An overview on the main recommendations and concerns will be presented in the following:

Please find the Consultation Paper and the responses here: http://www.esma.europa.eu/consultation/Consultation-Draftimplementing-technical-standards-under-MiFID-II

: Format and timing of communication and publication regarding suspension and removal of financial instruments from trading venues  Three respondents pointed out that publication on websites should not be considered as the main communication channel as efficient services are already established in the market.  Some changes in ESMA’s format for communication and publication were requested.  The suspension of one financial instrument often implies the suspension of numerous derivatives thereof, leading to quality problems in case of the obligation to ‘immediately’ publish a suspension.

ESMA published additional draft Regulatory Technical Standards (RTS) for the central clearing of Interest Rate Swaps (IRS). The published RTS propose mandatory central clearing of fixed-to-float IRS and Forward Rate Agreements (FRA) in Norwegian Krona (NOK), Polish Zloty (PLN) and Swedish Krona (SEK). ESMA develops RTS to implement the European Market Infrastructure Regulation (EMIR) which has the objective of reducing systemic risk and thereby introduces the obligation to clear certain classes of Over-theCounter (OTC) derivatives.

IRS denominated in EUR, GBP, JPY and USD were already proposed for mandatory clearing by ESMA earlier this year. These RTS were endorsed by the EC in August 2015, leading to an expected start of central clearing in Q2 2016.

 Before IM is exchanged, both entities will need to be eligible under the regulations

So far, ESMA proposed central clearing for different types of derivatives, including Index Credit Default Swaps (CSDs) as mentioned in the last issue of our newsletter. ESMA’s assessment whether a class of OTC derivatives should be subject to central clearing is based on a number of criteria, including liquidity, price availability and standardization.

 IM will need to be segregated at a third party custodian with appropriate protection in place for both sides of the transaction to receive all the collateral posted in the event of a default in either party

The draft RTS have to be endorsed by the EC within three months, followed by a non-objection period by the European Parliament and Council. The central clearing obligation for fixed-to-float IRS and FRA denominated in NOK, PLN and SEK is set to reduce systemic risk. This is the case as these contracts have huge trading volumes leading to systemic relevance for local (as well as the overall European) market.

 IM will either be a standardized model detailed in the regulatory text or a quantitative model e.g. ISDA Standard Initial Margin Model (SIMM)

 The regulations cover the assets which are eligible to be posted as collateral, applicable haircuts and treatment of concentration risk and wrong way risk  FX swaps and forwards are exempt from margin, however, trades cleared over unrecognized Central Counterparties (CCPs) are to be included in margining calculations This paper will document the US Prudential Regulators (PRs) rules and explain their impact. It will also highlight the need for market consensus and centralization in order to provide the best environment to allow for agreement of the collateral calls and ensuring that the appropriate amount of collateral is called.

Please find press release here.

In September 2013, the Basel Committee for Banking Supervision (BCBS) finalized BCBS 261 – Margining Requirements for NonCentrally Cleared Derivatives, providing guidelines with the view of reducing the potential systemic impact of a default within the uncleared OTC market and encouraging organizations to use cleared OTC products. The Federal Deposit Insurance Corporation (FDIC), one of the Prudential Regulators in the US, is the first regulatory body globally to have finalized their framework for the margining of uncleared OTC derivatives, and it remains to be seen how much influence this has on the other regulatory bodies as they compile their final regulations. The OTC market was measured as having in excess of 550 trillion USD of open notional value (BIS, Nov 2015) and the products, by their nature, are at the complex end of the spectrum. Any change in this market is both significant and challenging. The main points of the regulation to highlight are:  Variation Margin (VM) becomes mandatory for covered swap entities (CSEs) and financial end users  Initial Margin (IM) will be required between the same set of participants, however, this will be phased in over time, starting with the largest entities

The rules remain largely unchanged from the draft. The calculation to understand if an organization is to be included within IM exchange is still based on the daily average aggregate notional between March and May each year, VM remains in line with BCBS with a 16 Sep initial tranche (for entities under those groups with greater than 3tn USD in open uncleared notional) and 17 Mar for parties of groups with more than 8bn USD of uncleared notional. Also in line with the initial draft paper, only trades executed after the date where both parties fall in scope in the new regulations are captured by these requirements, however, the backloading of trades is permitted. The decision to do this would be driven by both an internal assessment of the costs involved against the reduction in existing costs, such as risk-weighted assets (RWA), and with the agreement of the each particular counterparty.

01 Sep 2016

EUR 3tn

Initial and Variation Margin

01 Mar 2017

EUR 8bn

Variation Margin only

01 Sep 2017

EUR 2.25tn

Initial Margin only

01 Sep 2018

EUR 1.5tn

Initial Margin only

01 Sep 2019

EUR 750bn

Initial Margin only

01 Sep 2020

EUR 8bn

Initial Margin only

Note that in the above table when calculating the notional exposure the US PRs stipulate that, when considering intra-group trades within the calculation, only one side should be counted. There will

also be a periodic review of the USD values, to allow recalibration to keep them in line with the BCBS EUR denominated values. Given the current drafts of the new ISDA Credit Support Annex (CSA) documentation, any recalibration of FX rates will cause a significant amount of repapering. These amounts are currently ‘hardwired’ into the legal documents and would therefore require a renegotiation of the document causing a significant overhead, both in terms of time and resourcing. A protocol is in development that could assist to alleviate the impact, but will not remove the overhead completely. To add some context to this, large banks will need to negotiate tens of thousands of CSAs with counterparties within a compressed timescale (until the final regulations come out the new documentation cannot be finalized) therefore requiring a significant resourcing effort, which poses its own set of issues, or acceptance that the task will not be completed in time leading to prioritization of parties. Given the above table, entities could move in and out of scope – especially from 2020 onwards – as the group notional level fluctuates above and below the threshold. The way this is dealt with in the US rules are very generous for entities coming in to scope only new trades are subject to margin; for those falling out of scope no trades, legacy or new, need to be margined. The definition of trades for inclusion also addressed the definition of ‘uncleared swap’. The regulations include trades that are not cleared by organizations registered with the CFTC or Securities and Exchange Commission (SEC) (note that if anything is cleared through any such organizations they will require double margining).

(details in the paper). Where at least one party is a financial end user the pool of eligible collateral matches that for IM  Limits are put on collateral holdings in order to minimize concentration risk  Monitoring of wrong way risk, requiring that collateral be rejected if it is issued by a related entity to that which it is collateralizing Within the regulations it seeks to cover FX risk between the trades being collateralized and the collateral used to cover the credit risk. The method they have chosen to do this is with the application of an 8% currency mismatch haircut. Crucially, it only applies to non-cash VM and all IM not placed in the ‘currency of settlement’. A definition of ‘currency of settlement’ is included in the paper. The paper prohibits the modelling of an 8% haircut and explicitly says it is additive to the standardized haircuts – therefore if the usual haircut is 5% but it is being used to cover a portfolio denominated in a different currency then the haircut to be applied is 13%. This is, of course, an issue as normally portfolios hold multi-currency products and are collateralized on a portfolio basis. There is no mapping between collateral and exposure trades. Therefore the industry is pushing for the definition to relate to the base currency of the CSA. Another welcome change from the draft requirements is the relaxation of only a single CSA sitting under eligible netting master agreement (ENMA). Whilst there is a huge amount of repapering to be done to ensure that all the CSAs with in-scope counterparties are regulatory compliant, this change means that multiple CSAs can now sit under a single netting agreement rather than having to negotiate a new one.

Elements of the PR’s paper, such as the threshold for inclusion for IM, require a view at group level. The identification of a group member is their inclusion into the parents’ consolidated accounts.

VM is a widely used tool within the financial markets. However, until this regulation this was an entirely voluntary process. Going forward the regulations specify the types of counterparty with which entities must exchange VM. In the US regulations they specify two types of counterparty that must exchange VM: covered swap entities and financial end users (the regulatory text provides precise definitions for these terms). Interestingly, swap entities have a collect only requirement – note though that if two swap entities are collateralizing with one another this will result in a pay and receive. VM must be exchanged based on the following regulatory prescribed minimum standards:  There is no VM threshold  VM will be calculated using mid prices  VM must be posted the day after execution  A minimum transfer amount of no more than 500k USD is allowed to be split over IM and VM  For VM transfer between swap entities, the rule remains cash only but has been extended to USD or any other major currency

The IM requirements are broadly in line with the BCBS guideline document. However, there is some clarification of the details which will cause some issues and the response to which should be considered carefully. IM must be calculated on a daily basis regardless of what model is used (modelling of IM is covered in the section below). IM must be exchanged the day after the calculation day. Timings for IM are recognized as aggressive and there is concern in the market that it fails to allow the requisite period of time for some fixed income products to settle, and consequently, this has drawn the attention of industry lobbying groups. The solution mooted is to post collateral that settles in a short time period e.g. cash, and substitute it out later. IM must also be posted whilst a dispute is being investigated. Under the new regulations, IM must be calculated on a trade no later than the business day following a transaction. However, the PRs have clarified some details around definitions and exceptions to this. Timing of execution and location of the other party can move this: if the trade is executed after 4pm locally the day of execution is deemed to be the following day; if a trade is executed on different calendar day between the two parties e.g. Japan and US, then the

execution date will be the latter of the two; if a trade is executed on a non-business day of one party the trade is deemed to be executed on the next good business day. The PR regulations also stipulate a variety of other requirements pertaining to the IM process. It provides for a threshold of 50m USD at the 'consolidated entity' level. The US rules made it clear that the definition of group is all those entities that are included in the consolidated accounts. This can be apportioned across the bilateral relationships between those groups. Any non-VM is to be segregated at an unaffiliated custodian(s) including any existing independent amount (IA) requirement. There are concessions to this covered under the intra-group margining section. Cash pledged to a custodian may be held in a general deposit account if the funds are used to purchase an asset (eligible collateral) and segregated within a reasonable time period. The market view is that no firm wants to use this facility but instead wants to keep this as an option in the event of a severely stressed market where non-cash products are difficult to source. The regulations also clarify that the requirement is generally for parties to post and collect (except for trades between swap entities where both sides are required to collect, resulting in post and collect). Finally, the haircuts on collateral are listed in appendix B of the PR’s document and are broadly in line with BCBS, but with some amendments around mid-cap equities, an additional inclusion from the BCBS document.

The regulations do provide additional clarity around the modelling requirements for IM. Any quantitative model must operate to a 99% one-tailed confidence interval over a 10-day close out period, a standard BCBS guideline. Other elements that are constant are that the PRs must approve all models prior to their use and, in the event the model is not signed off, the standardized model must be used. Other rules are annual model reviews, annual data reviews, periodic supervisory reviews, ‘robust oversight, control and validation mechanisms’, independent validation of the model prior to implementation and on an on-going basis – including backtesting. This is the cause of a lot of industry debate as to exactly how backtesting should be conducted and what oversight, controls and validation mechanisms would be considered ‘robust’ by the regulators. This in turn is leading to a lot of debate as to how prescriptive industry bodies should be and where there is a single correct answer. Any model changes must be communicated to the PRs 60 days before implementation for review and provide time to retract prior approval. The standardized model remains unchanged. One crucial interpretation is that the rule also highlights that common risks or risk factors across asset classes cannot be recognized. It also highlights that segregation is required at the product level rather than the existing risk factor decomposition process. Additional detail is provided in the paper.

This is likely to cause a significant issue within the market as the ISDA model had assumed that the asset class bucketing could be done at the risk factor level rather than the trade level (and indeed other regulatory bodies have intimated that this approach was acceptable). This creates a problem for the market, for which analysis is being undertaken at the moment, to decide whether it is economic for two versions of the model exist; one segregating by the asset class of the product and the other segregating down risk factor lines. Different organizations see different impacts, based on the size, complexity and the breadth of asset classes within any given portfolio of trades. In addition to the industry question, there are impacts to the in-house process of compiling the trade groupings for the IM process. This revised approach from the PRs requires trades being passed through the SIMM model has an asset class associated to it (this will already be required for the Current Exposure Method (CEM) model, although this is likely only to be used to pick up outliers rather than the bulk of the trades and therefore has a reduced impact). Whilst this adds an extra step into a process that has to be created anyway, it leads to a further question around the taxonomy required to provide the asset class assessment. As with most aspects to the IM computation, there is a need for this to be solved within the market as it is critical that parties use the same taxonomy to classify the trades in order to minimize the chances of a dispute. There are many taxonomies within the market (there can be multiple taxonomies within an organization) but ideally a single market standard should be found to allow consistent identification of an asset class, allowing identical margining treatment from both parties of the transaction.

Trading between jurisdictional boundaries will be very complex once the rules come into force given the lack of a single harmonized regulatory framework. Without cross-border trading, liquidity will dry up in some locations. The regulations define overseas entities by the place of incorporation. Substituted compliance (adoption of the counterparty’s regulatory regime) is permissible if it is deemed by the PRs that the overseas framework is comparable. This will be performed upon request to the PRs on a jurisdiction by jurisdiction basis. This compliance ruling may be conditional or unconditional. Only swap entities can ask for the review. Prior to equivalence being granted the US rules must be followed. Trading in locations where netting/segregation is unavailable, such as China and Middle East countries, can be excluded from margining requirements subject to prior written approval on the basis that it meets a number of requirements identified in the paper.

Intra-group margining is still in force for IM and VM, a marked difference to the draft rules elsewhere. This is potentially a large

overhead for institutions looking to hub their risk management processes. However, between the US entity and its affiliates there is a 20m USD threshold. It also allows for the affiliates or the swap entity to act as the custodian for non-cash IM. Another concession is that swaps that could be cleared but for an exemption these are only required to be subject to a 5-day Margin Period of Risk (MPOR). It is likely that this will be difficult to apply, however, this could be deferred until post go-live as the 10-day margining could be used in the interim. Intra-group margining regulations also state that swap entities will only be required to collect IM from affiliates designated either as a swap entity or a financial end user with material swap exposure. Additionally, IM collected by the US party is exempted from the need to be housed at a third party custodian.

There are caveats, but as a rule of thumb these regulations will be used whenever an entity transacts with a US domiciled entity. Crucially, when a party is domiciled in a location without rules governing uncleared OTC margining, they would need to comply to these rules – as they apply to their trading counterparty, and should be aware of these regulations and the increased financial, monitoring, compliance and control burden. The US PRs are the first regulatory body to issue final regulations on this subject, however other bodies have issued a consultation document. As at now Japan, the EU, South Africa, Singapore and Canada have all released draft papers. When looking to address these regulations there are a number of aspects to consider, including, revenue protection, increase in costs, market dynamics and global coverage. Firstly, let us explore the possible changes to client motivation and behaviour. Will they want to continue to trade these products with entities in regulated locations and subject themselves to increased costs? It could be argued that local firms would be able to provide these products without the burden of regulatory margining. How can firms encourage their clients to continue their existing business? Will the existing selling points of access to global markets, diverse asset class and product offering or being a ‘onestop shop´ for their requirements be enough? It is quite likely that clients will reduce their portfolio of broker dealers down to a smaller number to maximize the margining offsets and minimize their costs. In order to retain this business the case for value-added services rather than competing on costs becomes greater. For example, can these organizations reduce the impact for the client by performing the IM calculations on their behalf and provide them for their collateral management (a sole valuation agent approach)? Would they be able to take this to the next step and assist with access to pools of appropriate collateral?

Secondly, for the large organizations captured in the first wave of regulatory margining, revenue protection and cost increases can be addressed together. The initial tranche of institutions captured for IM will be the large global players. This opens an interesting dilemma for these organizations in addressing their global coverage, existing client reach and centralized/hubbed risk infrastructure. In order to protect revenue and offer the existing suite of products to clients there are several aspects to look at to address viability. Thought should be applied to look at site reduction versus the cost of implementing a solution in that location. Site reduction would only mean not being able to trade in-scope products with in-scope counterparties, not an overall cessation of trading. If a trade is executed through a local entity, does the legal setup of the company and the regulatory regime mean that margining with a client is required (a subsidiary is sometimes exempt from the regulatory requirements of the parent, as opposed to a branch)? Does the revenue of the counterparty/product combination justify a solution in that location? Can clients be encouraged to retain their relationship and trade in another location (which has a solution) rather than through a local entity? Thirdly, firms also need to consider the implication of intra-group margining. As discussed above, there is no exemption for intragroup margining, but there is a 20m USD threshold per entity. Assuming a centralized risk management structure, it is likely that within a few months this threshold would be breached and costs will increase. Similar to the above questions around the implementation of a margining solution, is there a case for decentralizing risk management? Can the local entities manage their risk effectively? There would likely be benefits in the ease and sophistication of any margining solution implemented but overall management of the group would likely be significantly more difficult to manage. Fourthly, there should also be consideration of the impact market vendors will have on the provision of a solution for this regulation. There are a few vendors working on offerings at the moment e.g. NetOTC and AcadiaSoft. As has been referred to previously, there is a need for commonality within the market if an effective solution is to be found. These vendors will help with that. What appetite is there for these vendors? How certain are organizations that these solutions will be in place for the implementation date? If a vendor misses the regulatory go-live date then they are not liable for regulatory sanction, unlike the banks. Therefore, banks will develop solutions in tandem with any external solutions they are considering to ensure that they are compliant with the regulations. Additionally, as time goes on, more parties and trades are captured within the margining regulations and as IM requirements increase there is likely to be a scarcity of eligible collateral. Given that IM needs to be locked away in a third party custodian and this cannot be re-hypothecated, there could be a lack of the quality collateral

demanded within the market. This could lead to an increase in the activity and importance of the stock borrow/lend and repo markets for sourcing suitable assets. Attention will grow on these functions to ensure that collateral can be sourced for use internally, and possibly also for their clients. Finally, as an output of all the above, managers will need to address reputational risk. The inability to meet this high profile legislation will lead to other market participants reducing or ceasing their relationships with a party. By not being able to provide certain services or parties being subject to punitive terms, there will be significant implications to being able to do business within the market, with the impact being felt far further than just the trading of uncleared OTC products. Compliance to these requirements is a very complex and time consuming process and should not be underestimated otherwise costs could spiral significantly to the point where trading uncleared OTCs will be prohibitively expensive. Against the backdrop of multiple regulatory drops form a range of locations there is a significant cross-border implication to trading which also should be considered by existing and new participants into this large and necessary market.

As has been previously mentioned, this is only the first set of regulations provided. There are currently about seven other bodies with published draft regulation. One assumes that, given the BCBS is a G20 organization, the other members of the G20 will be pressured to implement the regulation. The implication of this is significant. This paper has predominantly dealt with the impact of the PR’s requirements. Banks need to consider how best to fundamentally manage their uncleared OTC business including; retention of their current client base, minimizing costs, what attitude they take to their risk management, how their booking models need to evolve, how to manage relationships across their group and what models are used and how they will be implemented. In addition to this, there is the likelihood that there will be divergence between the various national regulators. Decisions will need to be made within organizations how these differences will impact the current cross-border business as it remains to be seen how regulators will interact with differing legislation and how they see cross-border interactions. Whilst this has been a consistent line of lobbying by the industry to the regulators any inter-regulator liaison has been conducted very much behind closed doors. Given the breadth of the topic, future newsletters will look in greater depth into some of the issues raised by this regulation.

On 30 October 2015, Euroclear group informed the ECB that Euroclear Belgium, Euroclear France and Euroclear Nederland will not migrate to the T2S platform as planned. In the official T2S migration plan, these Euroclear Central Securities Depositories (CSDs) were planned to migrate onto T2S along with NBB SSS (Belgium) and Interbolsa (Portugal) as part of the second go-live wave on 28 March 2016. NBB SSS and Interbolsa are still reported to be on track with their preparations. Issues in internal preparations for migrating to the T2S platform apparently are the root cause for Euroclear’s delay, according to the official statement made by the ECB (see https://www.ecb.europa.eu/paym/t2s/html/index.en.html). The delay shall ensure a smooth migration at a later stage and benefit the stability of the T2S platform and the financial market in general. The ECB Governing Council, T2S Board, Euroclear and National User Groups (NUGs) will assess the impact of the delay on the overall T2S community and will identify the most suitable way going forward in the migration. A proposal on the Steering Level was scheduled to be finalized by 09/10 December 2015, while the final resolution will be proposed to the ECB Governing Council in January 2016.

As the T2S governance bodies and Euroclear reassess the migration schedule, the market seems to be favoring a sequential push-back of the subsequent migration waves. This is due to two key constraints. On the one hand, reversing the go-live of the volumeheavy markets France and Germany is unlikely, since migration preparations of Clearstream Banking Frankfurt (CBF) are grounded on the prerequisite that the Euroclear CSDs have already migrated onto the T2S platform and CBF (and its participants) require at least half a year for migration testing. On the other hand, a big bang migration with Euroclear CSDs and CBF migrating in the same golive wave is as well unlikely, given previous concerns of concentration risks around the original migration schedule discussions. Therefore, the most likely scenario may unfold as follows:  Interbolsa and NBB SSS could migrate as planned, i.e. in T2S Wave 2 on 28 March 2016  The Euroclear CSDs in France, Belgium and the Netherlands may be postponed by 6 months, roughly matching the original migration date for T2S Wave 3, i.e. 12 September 2016  T2S Wave 3 (among others CBF) may be postponed by 6 months to a new migration date in March 2017  The original T2S Wave 4 (among others Iberclear) may be postponed as well by 6 months to a new migration date in September 2017

Given that this ‘most likely scenario’ may or may not unfold as anticipated here, stay tuned for more updates on the road ahead for securities settlement in Europe.

To develop such a benchmark within the risk assessment of Credit Valuation Adjustments (CVA) the EBA provided the CVA Report to be able to analyze the detailed practices applied by an institution and quantifying the impact when CVA is included in the calculation of own funds requirement transactions exempted under article 382 of Capital Requirement Regulation (CRR3).

As of 19 December 2014 the European Banking Authority (EBA) published the guidelines on common procedures and methodologies for the supervisory review and evaluation process (SREP) with the purpose to develop Europe-wide standards and consistency concerning the expectations, actions and measurements for the risk management and the capital as the liquidity adequacy of institutions (also known as ICAAP1 & ILAAP2). The SREP framework plotted in figure 1 below has been described in the 2nd issue 2015 of Capco’s Regulatory Monitoring Newsletter.

Now as the EBA recommends defining a coordinated approach to capture and monitor CVA risks, the banking authority published a consultation for the guidelines on the treatment of CVA risks under the SREP on . These guidelines determine a European approach to assessing the materiality of CVA risks, its assessment under the SREP and defining additional own funds requirements; the framework is shown in figure 2 on page 9.

quantitative capital measures

assessment of risks and controls

assessment of risks and controls

determination of own funds requirements & stress testing

determination of liquidity requirements & stress testing

capital adequacy assessment

liquidity adequacy assessment

quantitative liquidity measures

other supervisory measures

Figure 1. Framework of the supervisory review and evaluation process (SREP); compare to the guidelines on SREP

In the first step the guidelines determine the significance of a derivatives portfolio according to the exceeding of a certain exposure (threshold 1) or a specified ratio of CVA risks totaling risk exposure amount (threshold 2). Institutions meeting at least one of these criteria are required to calculate the materiality (threshold 3) as a ratio of hypothetical own funds requirements for CVA risks to hypothetical total risk exposure amount. In comparison to threshold 2 the “hypothetical” ratio (in threshold 3) re-includes EU and non-EU non-financial counterparties, sovereign, pension funds and intragroup transactions which are exempted under Title VI of CRR. Specifically, institutions using the advanced calculation method should use the proxy spread for these transactions due to the nature of the associated counterparties which often do not have CDS spreads quoted on the market or for which the seniority of derivative transactions may differ from the usual convention used to compute market Loss Given Defaults (LGDs)4. The above mentioned steps are comparable to the “categorization of institutions” and “monitoring of key indicators” in the SREP framework. For institutions passed the materiality threshold (3) competent authorities are asked to assess and score the CVA risk in accordance to the definitions and considerations in Section 6.3.4 of the SREP Guidelines. Furthermore they should investigate the quality and the results of supervisory measures for CVA risks to detect deficiencies pursuant to Section 10 of the SREP Guidelines. These steps are congruent to the grey marked sections and the overall SREP assessment in the SREP figure. In dependence to the results of the previous steps competent authorities are asked to measure the hypothetical own funds requirements for CVA risks (including exempted transactions) as a certain percentage of the total amount of CVA risks in threshold 4 and the preparing steps. Through a Europe-wide benchmarking the competent authorities are hold to investigate the additional requirements.

Competent authorities assess and score CVA risks individually as part of SREP

Sizeable derivatives exposure (EAD ≥ X EUR) Calculation of hypothetical own funds requirements for CVA risks and comparison with materiality threshold

Materiality threshold (≥ X %)

Relevance threshold (≥ X %)

Guidelines do not apply

Guidelines do not apply

Competent authorities assess adequacy of held own funds for CVA risks and determine additional own funds req.

Competent authorities compare benchmark of supervisory value to existing and available own funds requirements req.

Supervisory benchmark (ratio of own funds ≤ X %)

Competent authorities consider applying additional own funds requirements

Figure 2. Framework on the treatment of CVA risks under SREP; compare to the guidelines on treatment of the CVA risks under SREP

Competent authorities decide on the need for supervisory measures in risk management and controls

CVA risks adequatly capitalized -> no need for additional own funds req.

The consultation paper asks the institutions to comment especially on the above mentioned calculation methods and the possibilities for calibrating these methods (ratios). Here, institutions should be aware to involve in that quality process of the EBA and to send their comments by 12 February 2016. Nevertheless the guidelines show already that . Institutions should be prepared to implement a corresponding reporting for the competent authorities. Although not all institutions will be affected by all steps of the CVA framework competent authorities are expected to harmonize requirements and regulatory expectations in general. Hence

1. Internal Capital Adequacy Assessment Process, ICAAP 2. Internal Liquidity Adequacy Assessment Process, ILAAP 3. See Regulation (EU) No 575/2013 4. See also Policy Recommendations 7 and 8 in the CVA Report

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