Derivatives clearing, exchange-trading and collateral in Germany

Types of transaction

What categories of equity derivatives transactions must be centrally cleared and what rules govern clearing?

All entities active in the EU derivatives market (whether banks, corporates, funds, SPVs, etc, and whether using derivatives for hedging or investment purposes) are impacted by EMIR, which imposes three main obligations on EU derivatives market participants (subject to limited exemptions) by staggered deadlines, with the latest having applied at the end of December 2018.

What categories of equity derivatives must be exchange-traded and what rules govern trading?

In Germany, no mandatory trading rules apply in respect of equity derivatives. Equity derivatives are not required to be traded on an exchange. If, however, equity derivatives are traded on an exchange, the rules governing the trading of these derivatives depend on the relevant market segment. On the regulated market, trading is governed by the Exchange Act, the Exchange Order and respective guidelines of the exchange. In respect of non-regulated markets, the exchanges have set up terms and conditions governing the trading on these markets.

Describe common collateral arrangements for listed, cleared and uncleared equity derivatives transactions.

Uncleared equity derivatives are subject to the bilateral collateral arrangements of the parties. Usually, parties collateralise their transactions under an ISDA collateral support annex or the equivalent DRV collateral addendum. Any transaction will be valued and a shortfall or excess will be determined on a net basis. The parties are required to provide relevant collateral to cover any shortfall or reduce any excess. The collateral is transferred by way of an outright collateral transfer allowing the collateral taker to reuse the collateral.

In this respect, a new European regulation has been introduced: Regulation (EU) No. 2015/2365 of 25 November 2015 on transparency of securities financing transactions and of reuse and amending Regulation (EU) No. 648/2012 (SFTR). It allows market participants to access secured funding (ie, to use their assets to finance themselves). This involves the temporary exchange of assets as a guarantee for a funding transaction. Examples include lending or borrowing of securities, repurchase or reverse repurchase transactions, buy-sell back or sell-buy back transactions, or margin lending transactions. The SFTR shall enhance transparency by introducing a reporting obligation for all securities financing transactions, disclosure obligation for investment funds on the use of SFTs and some minimum transparency conditions that should be met on the reuse of collateral, such as disclosure of the risks and the need to grant prior consent.

Apart from the clearing obligation (see question 21), article 11 of EMIR sets out certain risk mitigation techniques for OTC derivatives contracts not cleared by a central counterparty (CCP), including the timely, accurate and appropriately segregated exchange of collateral with respect to OTC derivatives contracts. This also affects equity derivatives. The implementing regulatory technical standards (RTS) on risk mitigation techniques for OTC derivatives contracts not cleared by a CCP under article 11(15) of EMIR were adopted on 4 January 2017. The new rules set out requirements for the collection of variation margin (VM) and initial margin (IM) in respect of OTC derivatives transactions not cleared by a CCP. VM is calculated by reference to the current market value of the OTC derivative and is to be collected from the party that is ‘out of the money’. Although the valuation used to calculate the VM requirement will be continually refreshed, there is always some risk that the market value of a particular contract will increase and a default occur before additional VM is delivered. The IM requirement creates an additional buffer that is intended to reduce the risk of a shortfall in that scenario. IM, where applicable, is posted by both parties and the amounts to be posted are not offset against each other. Non-financial counterparties (ie, corporates) are exempt from the collateralisation rules to a large extent and subject to certain conditions.

It should be noted that any equity derivatives that may become subject to mandatory clearing in the future will have to comply with the collateral requirements of cleared derivatives, which are more detailed and restrictive.

Must counterparties exchange collateral for some categories of equity derivatives transactions?

There are no specific rules for equity derivatives transactions. The general collateralisation rules of EMIR apply. See question 24.

Under the current final draft RTS for the margining of non-cleared derivatives, the provisions as regards eligible collateral require that the collateral-taker has access to the relevant markets and is able to liquidate such assets in a timely manner. Parties may agree to deliver the following eligible assets:

• cash (or similar, such as money-market deposits);
• gold (in the form of allocated bullion);
• sovereign securities;
• debt securities issued by credit institutions and investment firms;
• corporate bonds;
• the senior tranche of certain securitisations;
• equities included in a main index (or related convertible instruments); or
• shares or units in UCITS.

These broad classes are also subject to separate credit quality and wrong-way risk requirements and, in the case of IM, concentration limits. The RTS confirm that IM may be collected in cash, as long as it is held in accounts with a central bank or an EU credit institution that is not affiliated with the collateral provider or collateral taker.