ESMA proposes changes to CCP anti-procyclicality requirements
20 July 2023 EU
Image: AdobeStock/Ricochet64
The European Securities and Markets Authority (ESMA) has published a final review of its measures to address procyclicality of margin requirements at a central counterparty (CCP).
In its final report, the EU securities market regulator has suggested amendments to regulatory technical standards (RTS) to drive further harmonisation of CCP frameworks for identifying and mitigating procyclicality in their margin policies.
These recommendations aim to reinforce the ability of CCPs to contain the impact of large margin changes on clearing participants and their clients. They are also designed to prevent pockets of liquidity stress creating contagion in other parts of the financial ecosystem.
In doing so, the final report provides further details on the design and application of anti-procyclicality (APC) tools, while reinforcing the ability of CCPs to adapt to stress situations.
Under the European Market Infrastructure Regulation (EMIR) Article 41(5), CCPs are required to monitor and, when necessary, to revise margin levels to current market conditions, taking into consideration the procyclicality impact of any such revisions.
ESMA requires that CCPs adopt at least one of three APC margin measures.
It may apply a margin buffer of at least 25 per cent of the calculated margins, which it may allow to become temporarily exhausted in conditions where calculated margin requirements are rising sharply.
Second, it may apply a weight of at least 25 per cent to stressed observations in the “lookback period” calculated in line with Article 26 of the regulatory technical standards.
Third, it will ensure that margin requirements are no lower than would be calculated using volatility estimated over a 10-year historical lookback period.
ESMA’s requirements for CCPs, including its APC margin requirements, were codified within the EMIR Delegated Regulation, with the final report on these guidelines being issued on 28 May 2018.
Since the adoption of the RTS and CCP guidelines, these policies have been put to the test under a range of stress conditions and ESMA has suggested amendments based on experience gained under these stress scenarios.
One example was the surge in market volatility and severe liquidity tightening in March-April 2020 with onset of the Covid pandemic. A second was the impact of the Russian invasion of Ukraine.
Responding to these developments, ESMA issued a consultation paper in January 2022, inviting industry feedback on proposed draft changes to the RTS relating to APC measures and tools.
Subsequently, ESMA raised further questions regarding whether volatility shocks resulting from the Russia-Ukraine conflict, particularly in energy and commodity markets, have accentuated liquidity strains on certain clearing members, particularly among non-financial counterparties.
It notes that some commodity traders and other non-financial counterparts have experienced additional pressure because they do not have easy access to liquidity during stress events.
ESMA notes that in some cases price and margin changes may be larger than the 25 per cent buffer. Consequently, the proposed amendments require CCPs to consider a larger buffer under certain circumstances.
CCPs should also clearly document the circumstances under which the buffer can be exhausted and how it should be replenished. While it is not possible to have a pre-defined exhaustion strategy that will be optimal under all stress conditions, ESMA indicates that a CCP should be able to justify its actions as it applies this buffer facility (parg 18).
ESMA has submitted its final report to the European Commission for consideration within three months. If adopted, the amended RTS will then be subject to ratification (ie ‘non-objection’) by the European Parliament and Council.
In its final report, the EU securities market regulator has suggested amendments to regulatory technical standards (RTS) to drive further harmonisation of CCP frameworks for identifying and mitigating procyclicality in their margin policies.
These recommendations aim to reinforce the ability of CCPs to contain the impact of large margin changes on clearing participants and their clients. They are also designed to prevent pockets of liquidity stress creating contagion in other parts of the financial ecosystem.
In doing so, the final report provides further details on the design and application of anti-procyclicality (APC) tools, while reinforcing the ability of CCPs to adapt to stress situations.
Under the European Market Infrastructure Regulation (EMIR) Article 41(5), CCPs are required to monitor and, when necessary, to revise margin levels to current market conditions, taking into consideration the procyclicality impact of any such revisions.
ESMA requires that CCPs adopt at least one of three APC margin measures.
It may apply a margin buffer of at least 25 per cent of the calculated margins, which it may allow to become temporarily exhausted in conditions where calculated margin requirements are rising sharply.
Second, it may apply a weight of at least 25 per cent to stressed observations in the “lookback period” calculated in line with Article 26 of the regulatory technical standards.
Third, it will ensure that margin requirements are no lower than would be calculated using volatility estimated over a 10-year historical lookback period.
ESMA’s requirements for CCPs, including its APC margin requirements, were codified within the EMIR Delegated Regulation, with the final report on these guidelines being issued on 28 May 2018.
Since the adoption of the RTS and CCP guidelines, these policies have been put to the test under a range of stress conditions and ESMA has suggested amendments based on experience gained under these stress scenarios.
One example was the surge in market volatility and severe liquidity tightening in March-April 2020 with onset of the Covid pandemic. A second was the impact of the Russian invasion of Ukraine.
Responding to these developments, ESMA issued a consultation paper in January 2022, inviting industry feedback on proposed draft changes to the RTS relating to APC measures and tools.
Subsequently, ESMA raised further questions regarding whether volatility shocks resulting from the Russia-Ukraine conflict, particularly in energy and commodity markets, have accentuated liquidity strains on certain clearing members, particularly among non-financial counterparties.
It notes that some commodity traders and other non-financial counterparts have experienced additional pressure because they do not have easy access to liquidity during stress events.
ESMA notes that in some cases price and margin changes may be larger than the 25 per cent buffer. Consequently, the proposed amendments require CCPs to consider a larger buffer under certain circumstances.
CCPs should also clearly document the circumstances under which the buffer can be exhausted and how it should be replenished. While it is not possible to have a pre-defined exhaustion strategy that will be optimal under all stress conditions, ESMA indicates that a CCP should be able to justify its actions as it applies this buffer facility (parg 18).
ESMA has submitted its final report to the European Commission for consideration within three months. If adopted, the amended RTS will then be subject to ratification (ie ‘non-objection’) by the European Parliament and Council.
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