A Directive on financial collateral seeks to reduce credit risk in collateral financial transactions between financial institutions. The purpose is to provide for the rapid and informal enforcement of financial collateral. States may not make the creation, protection, enforceability or admissibility of financial collateral arrangement dependent on the performance of any formal act.
States must ensure the entity taking collateral is able to realise the financial collateral by sale, appropriation or set-off or applying value in the discharge of a financial obligation or by setting the amount off or applying it to discharge the relevant financial obligation.
Appropriation is permissible only if agreed as part of the arrangement. States that did not allow appropriation prior to the commencement of the regulations in 2002 are not obliged to recognise it.
States must recognise the applicable close-out netting provisions even if the collateral taker or provider is subject to winding up or reorganisation. Close out netting may not be prevented by purported assignment, judicial or other attachment or other disposition of or in respect of such rights.
On insolvency, certain provisions are not to apply. Financial collateral arrangements may not be declared invalid or void where they have been concluded or that the financial collateral has been provided prior to the winding up, reorganisation or making of the decree or in a prescribed period prior to it or defined by reference to the commencement of such proceedings.
In 2012 the EU adopted the European market infrastructure regulation (EMIR). The aims were to
- increase transparency in the OTC derivatives markets
- mitigate credit risk
- reduce operational risk.
EMIR introduces reporting requirements to make derivatives markets more transparent. Under the regulation detailed information on each derivative contract has to be reported to trade repositories and made available to supervisory authorities trade repositories have to publish aggregate positions by class of derivatives, for both OTC and listed derivatives the European Securities and Markets Authority (ESMA) is responsible for surveillance of trade repositories and for granting and withdrawing accreditation
EMIR introduces rules to reduce the counterparty credit risk of derivatives contracts. In particular
, all standardised OTC derivatives contracts must be centrally cleared through CCPs if a contract is not cleared by a CCP, risk mitigation techniques must be applied CCPs must comply with stringent prudential, organisational and conduct of business requirements
The regulation also requires market participants to monitor and mitigate the operational risks associated with trade in derivatives such as fraud and human error, for example by using electronic means to promptly confirm the terms of OTC derivatives contracts.
Derivatives and Central Counterparties
EMIR provides a mechanism for recognising CCPs and trade repositories based outside of the EU. Once recognised, EU and non-EU counterparties may use a non EU-based CCP to meet their clearing obligations and a non EU-based trade repository to report their transactions to.
The recognition is based on equivalence decisions adopted by the Commission. These decisions confirm that the legal and supervisory framework for CCPs or trade repositories of a certain country is equivalent to the EU regime.
A CCP or trade repository established in this country can then apply to obtain EU recognition from ESMA. Once recognition has been granted, the CCP or trade repository can be used by market participants to clear OTC derivatives or report transactions as required by EMIR.
In addition to the equivalence of CCPs and trade repositories, the Commission can also develop equivalence decisions for other areas of EMIR, such as reporting, margins for uncleared derivatives and risk mitigation techniques, and non-EU trading venues.
Securities Financing Transactions
Securities financing transactions ) allow investors and firms to use assets, such as the shares or bonds they own, to secure funding for their activities. A securities financing transaction can be
- a repurchase transaction – selling a security and agreeing to repurchase it in the future for the original sum of money plus a return for the use of that money
- lending a security for a fee in return for a guarantee in the form of financial instruments or cash given by the borrower
- a buy-sell back transaction or sell-buy back transaction
- a margin lending transaction
In 2015 the EU adopted the securities financing transactions regulation (SFTR) to increase the transparency of SFTs by requiring all SFTs, except those concluded with central banks, to be reported to central databases known as trade repositories information on the use of SFTs by investment funds to be disclosed to investors in the regular reports and pre-investment documents issued by the funds
minimum transparency conditions to be met when collateral is reused, such as disclosure of the risks and the obligation to acquire prior consent.
The settlement finality directive (regulates designated systems used by participants to transfer financial instruments and payments. It guarantees that transfer orders which enter into such systems are also finally settled, regardless of whether the sending participant has become insolvent or transfer orders have been revoked in the meantime.
The participants to designated systems may be financial institutions, e.g. banks systems operators, such as central securities depositories (CSDs) or central counterparties (CCPs)
The SFD requires Member States to designate to the European Securities and Markets Authority (ESMA) the national systems and the respective system operators which are to be included in the scope of this directive and the national authorities that must be notified when insolvency proceedings are opened against a participant or a system operator.
Any transaction in securities must be followed by a post-trade flow of processes. These processes lead to the settlement of the trade, which means the delivery of securities to the buyer against the delivery of cash to the seller.
Settlement may occur on the day of the trade, but more often a number of days later depending on
the type of securities the type of trading venue and the type of market
CSDs operate the infrastructure that enables the so-called securities settlement systems. In particular, CSDs
- allow the registration and safekeeping of securities
- allow the settlement of securities in exchange for cash
- track how many securities have been issued and by whom
- track each change in the ownership of these securities
The EU has adopted a regulation the main objective of which, is to increase the safety and efficiency of securities settlement and settlement infrastructures in the EU. It does this by introducing
shorter settlement periods
- cash penalties and other deterrents for settlement fails
- strict organisational, conduct of business and prudential requirements for CSDs
- passport system allowing authorised CSDs to provide their services across the EU
- increased prudential and supervisory requirements for CSDs and other institutions providing banking services that support securities settlement
A 2009 regulation provides for monitoring of credit rating agencies. Credit rating agencies must be registered in order for their work to be used for regulatory purposes within the EU. They must submit their application to the Committee of European Securities Regulators. They must submit details of their policies and procedures and methods of managing conflicts of interest.
The CESR sends the application to the regulator in the home state which deals with registration. The CESR seeks to ensure consistent application of the regulation. Registration may be withdrawn. There are powers for supervision and investigation.
The European Securities and Markets Authority is responsible for registering credit agencies and has exclusive supervisory powers.
Financial institutions and investors are required to carry out their own evaluation of credit risks and must not rely solely or automatically on external ratings in order to evaluate the creditworthiness of an entity or financial instrument.
Credit agencies must establish a schedule indicating dates on which they will rate countries. They are to be rated at least every six months.
In order to avoid market disruption, ratings may only be published once stock exchanges have closed and at least one hour before they are reopen.
Investors in EU States must be informed of the facts and assumptions behind each rating.
Each credit rating agency may be held liable if it infringes the regulation, either intentionally or through gross negligence, causing damage to an investor or an issuer.
A rotation rule requires issuers of complex structured financial instruments change agency every four years. Credit rating agencies must disclose situations where the shareholder holds 5% or more of the agency’s capital or voting rights or 5% or more of an entity rated by the agency. If both holdings reach or exceed 10%, the credit rating agency is not entitled to rate the entity.
It is forbidden to hold 5% or more of the capital or voting rights of more than one credit rating agency, unless the agencies belong to the same group
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