On 22 May 2015, the European Securities and Markets Authority (ESMA) published an opinion on the impact of EMIR on Articles 50(1)(g)(iii) and 52 of Directive 2009/65/EC (the UCITS Directive).
In its opinion, ESMA calls for a modification of Article 52 of the UCITS Directive to take into account the clearing obligation of certain types of OTC derivative transactions (OTCs) required by EMIR. ESMA also highlights issues concerning Article 50(1)(g)(iii) of the UCITS Directive.
Under Article 52 of the UCITS Directive, the risk exposure of a UCITS to a counterparty in an OTC is not permitted to exceed 5% of the assets of the UCITS, or 10% where the counterparty is a credit institution.
ESMA believes that the UCITS Directive should not distinguish between OTCs and exchange-traded derivatives (ETDs) and, instead, the distinction should be between cleared derivative transactions and non-cleared derivative transactions. This would enable ETDs and cleared OTCs which display similar characteristics in terms of counterparty risk to be treated in the same manner.
For OTCs that are not centrally cleared, ESMA is of the view that there is no need to modify the UCITS Directive and the current counterparty risk limits set out in Article 52 should continue to apply.
For OTCs that are centrally cleared and ETDs, ESMA proposes that UCITS should have to look at the details of the clearing arrangements to assess counterparty risk. For example, EU clearing houses and non-EU clearing houses recognised by ESMA are subject to stringent requirements and should therefore constitute relatively low counterparty risk. Non-EU clearing houses that are not recognised by ESMA might be subject to standards that are not equivalent to those applicable to EU clearing houses and non-EU clearing houses recognised by ESMA. Therefore such clearing houses might constitute higher counterparty risk than EU clearing houses and non-EU clearing houses recognised by ESMA.
UCITS should also look at counterparty risk in respect of the clearing members that they use. The level of counterparty risk that a clearing member represents to a UCITS will largely be determined by the type of account segregation that the UCITS has in place with such clearing member.
Article 50(1)(g)(iii) requires that OTCs “can be sold liquidated or closed by an offsetting transaction at any time at their fair value at the UCITS’ initiative”.
In its opinion, ESMA acknowledges that some clearing houses do not accept this unilateral termination right. There is therefore currently a conflict between the operation of the UCITS Directive and the operation of EMIR for cleared OTCs of UCITS.