Benchmark and CSA
The following quotes are from a recent article in Risk titled "Esma: Eonia can be used in CSAs after 2020".
The Article 3 (1) (7) of the European Benchmarks Regulation (BMR), refers to
"determination of the amount payable under a financial instrument or a financial contract by referencing an index or a combination of indices". The regulation enters in full force on 1 January 2020. The question behind the interpretation of this sentence is to know if CSA referring to EONIA can still be legally used in Europe after that date. Not a minor issue certainly.
The quote from Feldkamp says "Esma agrees that it can be argued [...]". It does not say that it is ESMA's position that CSAs are not financial instruments, only that ESMA agrees that someone else can make that argument, a very different meaning.
But I'm not a lawyer, so what do I know about the meaning of a sentence?
I'm not a lawyer, but I'm a financial engineer (or at least I can claim that I'm one as the title is not protected, see the list of regulated professions in Europe). What about the following situation. I draw a derivative contract with a counterparty. The contract is a fixed v fixed swap that pays net 1 (thousand, million, billion, chose the amount according to your wealth) EUR in one-year time. The contract is under CSA with EONIA collateral. What is paid under such a contract? EONIA collateral rate, compounded over one year. Miracle, this is exactly the payoff, up to the notional payment, of the floating leg of an OIS. This is pure coincidence, I swear it! To make the things clean, I have to remove the collateral initial and final payments, but that can be easily done with a fixed amount payments. I write the fixed amounts contract as a loan and not a derivative, so it does not need collateral. (I can provide an exact term sheet if you hire me as a consultant ;) ) We put in place a netting agreement between the derivatives and the loans to avoid economic credit risk. This does not affect the collateral as the margin regulation explicitly prohibit to take those cross-products netting agreement into consideration for the computation of the collateral on derivatives. I have just created a legal synthetic OIS in EUR using derivatives, CSA and loans when a simple OIS would be illegal!
What is the goal of the regulation? Make the risk management of financial risk for people that need to manage it more difficult and requiring financial engineering or to make the market safer and more efficient? I see more of the former here, but maybe my eyesight is getting poor.
It is very good that the press asked this important question and was able to get an answer. That what the press should do and I congratulate the journalist for that. But personally, I would have preferred that such an announcement, which amounts to a regulatory decision, was done publicly, for example on the ESMA website and not in a private for-profit news magazine. If I was not a subscriber of the magazine, I would not know about this new ESMA policy.
The list of benchmark administrators registered under the new regulation can be found on the ESMA website at https://www.esma.europa.eu/benchmarks-register
Jakobus Feldkamp, senior policy officer for market integrity at the Paris-based European Securities and Markets Authority, tells Risk.net that CSAs will not be dragged into the BMR.
“Esma agrees that it can be argued that a reference to Eonia in a bilateral agreement on an individual exchange of collateral under an OTC derivative is not strictly ‘use of a benchmark’ in the sense of the BMR,” says Feldkamp.
The Article 3 (1) (7) of the European Benchmarks Regulation (BMR), refers to
"determination of the amount payable under a financial instrument or a financial contract by referencing an index or a combination of indices". The regulation enters in full force on 1 January 2020. The question behind the interpretation of this sentence is to know if CSA referring to EONIA can still be legally used in Europe after that date. Not a minor issue certainly.
The quote from Feldkamp says "Esma agrees that it can be argued [...]". It does not say that it is ESMA's position that CSAs are not financial instruments, only that ESMA agrees that someone else can make that argument, a very different meaning.
But I'm not a lawyer, so what do I know about the meaning of a sentence?
I'm not a lawyer, but I'm a financial engineer (or at least I can claim that I'm one as the title is not protected, see the list of regulated professions in Europe). What about the following situation. I draw a derivative contract with a counterparty. The contract is a fixed v fixed swap that pays net 1 (thousand, million, billion, chose the amount according to your wealth) EUR in one-year time. The contract is under CSA with EONIA collateral. What is paid under such a contract? EONIA collateral rate, compounded over one year. Miracle, this is exactly the payoff, up to the notional payment, of the floating leg of an OIS. This is pure coincidence, I swear it! To make the things clean, I have to remove the collateral initial and final payments, but that can be easily done with a fixed amount payments. I write the fixed amounts contract as a loan and not a derivative, so it does not need collateral. (I can provide an exact term sheet if you hire me as a consultant ;) ) We put in place a netting agreement between the derivatives and the loans to avoid economic credit risk. This does not affect the collateral as the margin regulation explicitly prohibit to take those cross-products netting agreement into consideration for the computation of the collateral on derivatives. I have just created a legal synthetic OIS in EUR using derivatives, CSA and loans when a simple OIS would be illegal!
What is the goal of the regulation? Make the risk management of financial risk for people that need to manage it more difficult and requiring financial engineering or to make the market safer and more efficient? I see more of the former here, but maybe my eyesight is getting poor.
It is very good that the press asked this important question and was able to get an answer. That what the press should do and I congratulate the journalist for that. But personally, I would have preferred that such an announcement, which amounts to a regulatory decision, was done publicly, for example on the ESMA website and not in a private for-profit news magazine. If I was not a subscriber of the magazine, I would not know about this new ESMA policy.
The list of benchmark administrators registered under the new regulation can be found on the ESMA website at https://www.esma.europa.eu/benchmarks-register
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