The Central Bank issued a Consultation Paper (CP 84) on 28 July 2014 on the adoption of ESMA's revised guidelines on ETFs and other UCITS issues (ESMA's Guidelines). ESMA’s Guidelines include a 20% of net asset value issuer diversification rule with respect to collateral received for the purposes of EPM techniques and OTC derivative transactions. As detailed in our March Front Page Bulletin, ESMA's final report (which issued on 24 March 2014) provides a derogation from the 20% collateral diversification rule for certain government backed securities. This derogation will be available to all UCITS rather than only MMF UCITS (as was originally proposed). The Central Bank, however, has expressed concern in relation to the extension of the derogation to non-MMF UCITS and accordingly has issued CP84 which outlines its proposals to implement the derogation from the 20% collateral diversification requirement. The Central Bank has proposed to make the derogation subject to a requirement to ensure that the non-cash collateral received by the UCITS is of “high quality”, taking into account various criteria specified in CP84. In summary, the Central Bank is proposing to implement ESMA Guidelines as follows:
- Provide that all UCITS may avail of the derogation from the collateral diversification requirement where the collateral consists of securities issued or guaranteed by a Member State, one or more of its local authorities, a third country or a public international body of which one or more Member States belong;
- Delete the existing rule in the UCITS Notices which requires that collateral received by UCITS must be “of high quality”; and
- Replace this with a rule to be added to the UCITS Rulebook, that UCITS may only accept "‘high quality" collateral and that in determining whether collateral is of high quality, UCITS shall be required to conduct an assessment, prior to accepting the collateral, which takes into account: the credit quality of the instrument; the nature of the asset class represented by the collateral; any operational risk; any other significant related counterparty risk; and the liquidity profile.
Where acceptance of collateral will bring the collateral issuer limits over 20% of the total collateral held by the UCITS, the UCITS will be required to apply additional resources to carry out a more detailed assessment of the credit quality of that collateral. Credit quality of already-accepted collateral must be monitored on an on-going basis. Where there is evidence of deteriorating credit quality of collateral held, the UCITS must implement a remediation plan.
Responses to the consultation are requested by 17 October 2014.