The next step in the EMIR implementation timeline is the authorisation of the EU central counterparties (CCP). The precise timing for this is unclear, but it is expected that some CCPs will be authorised in spring 2014. Upon authorisation, those CCPs and the clearing brokers who are members of those CCPs will have to offer the new client clearing structures.
We have been advising various clients on EMIR related issues, including the new client clearing structures and accompanying documentation, for some time and would be happy to help you understand the implications of the new client clearing structures. In the meantime we have prepared some background and a high level list of practical issues to consider.
What is client clearing?
Client clearing is the service provided by a clearing broker to its client under which the clearing broker agrees to clear that client’s transactions through a CCP of which the clearing broker is a member.
EMIR includes new requirements in relation to the provision of client clearing services. These requirements aim to provide certain protections to the clients of clearing brokers in the event that the clearing broker is declared to be in default by the CCP.
What are the EMIR requirements for client clearing?
Segregation of client positions and assets
In addition each client will have a choice over the level of segregation it wishes to have for its positions and assets in relation to the positions and assets of the other clients of its clearing broker. Clients will be able to choose between:
- an individual client account (where only positions and assets which relate to it will be recorded in the account with the CCP); or
- an omnibus client account (where positions and assets which relate to it will be recorded in the same account as positions and assets which relate to other clients of the clearing broker).
Actions upon the default of the clearing broker
If the clearing broker is declared to be in default by the CCP, the CCP will be obliged to:
- Try to transfer the positions and assets which relate to the client to a new non-defaulting clearing broker (this is known as “porting”); or
- If porting cannot be achieved, try to return the assets directly to the client rather than to the defaulted clearing broker (if the CCP cannot do this, then they will return them to the defaulted clearing broker for the account of the client).
Is client clearing the same as the clearing obligation?
Client clearing is not the same as the clearing obligation. The EMIR client clearing requirements must be met by CCPs and clearing brokers in respect of all client clearing services they offer regardless of asset class and whether they relate to OTC or exchange traded products. The EMIR client clearing requirements are not limited to clearing eligible OTC derivatives.
The clearing obligation is the EMIR requirement that will mean that certain counterparties will have to ensure that trades they enter into OTC derivatives which have been declared to be clearing eligible are cleared through a CCP. If a counterparty needs to clear a particular trade as a result of the clearing obligation, one way in which it can do this is by using the EMIR compliant client clearing services of a clearing broker.
What documentation are clients likely to receive from clearing broker(s)?
Client account offer letter - Clearing brokers are required to receive written confirmation from each of their clients regarding which type of client account they would like to have. Many clearing brokers will make this offer in a letter or email to which clients will need to respond to.
Client clearing documentation – Clearing brokers may wish to enter into new legal documentation with their clients setting out the arrangements for the EMIR compliant client clearing services. This may be done by way of a new standalone clearing agreement or it may be done by way of an amendment to the existing legal documentation between the clearing broker and client.
Disclosure document – Clearing brokers are required to publish a disclosure document regarding their EMIR compliant client clearing services. They may provide a hard copy of this or they may direct clients to a section of their website instead. Clients should review this document before confirming which type of client account they would like.
CCP documentation – some CCPs may also require clients to enter into legal documentation with them and the clearing broker. This could include various contractual acknowledgments and representations.
What type of areas should clients be thinking about when reviewing the client clearing documentation?
Clients should consider the following areas when reviewing any client clearing documentation from their clearing broker:
- Does the client clearing documentation amend any of the existing arrangements with the clearing broker? If so, how?
- How do the client clearing structure at each of the CCPs which the clearing broker uses work?
- Does the client clearing documentation require the client to comply with any of the CCP rules? If so, which rules?
- Collateral requirements – what will these be in relation to the clearing services? What type of assets can be provided as margin? Is the clearing broker offering any collateral services such as collateral transformation?
- Will the client receives client money protection from the clearing broker in respect of cash it provides as margin? How will the client clearing arrangements interact with such client money protection?
- Will the client clearing arrangements impact the regulatory capital requirements of the client?
- Are managers or other entities who as act agents for their underlying clients able to enter into the client clearing documentation with brokers? Does the documentation work if entered into by a manager/agent? Does the manager/agent have the relevant authorisation to enter into the documentation?
- How will managers (and other agents) inform their underlying clients about the client clearing structures? How will they know what type of client account to select for the underlying clients?
Will this impact you if you only trade in exchange traded products rather than conducting any OTC trading?
Yes. The EMIR client clearing requirements apply to all EU CCPs and their clearing brokers regardless of whether they are clearing OTC or exchange traded products.
Will this impact you if you only trade in non-derivatives e.g. equities?
Yes. The EMIR client clearing requirements apply to all EU CCPs and their clearing brokers regardless of the asset class that is being cleared.
Will this impact your arrangements with all of your clearing brokers?
A clearing broker which is a member of an EU CCP will need to offer its clients EMIR compliant client clearing services when that EU CCP is authorised under EMIR. This obligation applies to non-EU entities which provide client clearing services in respect of EU CCPs.
These obligations do not apply in respect of services offered in relation to non-EU CCPs.
When does all this become relevant?
Clearing brokers have been asked to start operating their EMIR compliant client clearing structures as soon as the CCPs they are using are reauthorised under EMIR. The precise timing for this is unclear but it is expected that some CCPs will be reauthorised in the spring of 2014. Clearing brokers have therefore started to distribute their new client clearing documentation and will be asking clients to choose their account types as soon as possible. If you do not confirm your choice, your clearing broker may allocate an omnibus client account as a default option but they are likely to keep chasing you for a response.
We would be pleased to help you with any of the following:
- Understanding the concept of clearing through a CCP, the risks it poses and how those risks can be reduced.
- Reviewing and negotiating (if appropriate) the documentation you have received from your clearing broker and how it compares to what might be the market standard.
- Deciding what account type to choose.
- Determining which rules of a CCP might be relevant to you.
- Working out how these new arrangements may impact on your relationship with any underlying clients.