EU lawmakers converge on centralising Simm validation

Industry cautiously optimistic Council and Parliament will support EBA compromise

Council of Europe building, Strasbourg

Photo: KH-Pictures / Alamy Stock Photo

Market participants believe there is growing support among European Union lawmakers for creating a co-ordinated supervisory process to validate initial margin models, while also exempting end-clients from the requirement.

A confidential draft text, produced by the Spanish government – which currently holds the presidency of the Council of Europe – and seen by Risk.net, proposes implementing in full a set of recommendations made by the European Banking Authority earlier this year. This would mean the EBA overseeing the validation of industry-wide initial margin models for non-cleared derivatives, such as the standard initial margin model (Simm) developed by the International Swaps and Derivatives Association.

We welcome the reproduction of the EBA opinion in the Spanish compromise text

Perrine Herrenschmidt, Isda

“We welcome the reproduction of the EBA opinion in the Spanish compromise text,” says Perrine Herrenschmidt, senior director of European public policy at Isda.

A senior bank executive agrees the text is “a step in the right direction…as long as the EBA isn’t at odds with all the other international regulators” on the validation process itself.

The European Commission proposed amendments to the European Market Infrastructure Regulation, dubbed Emir 3.0, in December last year. An earlier version of Emir from 2019 had given the EBA a mandate to draft regulatory technical standards (RTS) on Simm validation, but the EC’s proposal deleted this mandate.

When the EBA originally consulted on the validation RTS in 2021, it provoked a hostile response from market participants, who warned that fragmented supervision could jeopardise the use of Simm, which had been rolled out across the whole industry. In bilateral markets, it is essential to have a method for calculating margin that is agreed by both counterparties.

On July 6 this year, the EBA published an opinion paper that appeared to respond to these industry criticisms, proposing to centralise Simm validation and to apply the requirements to “at least the largest credit institutions in the EU above a certain threshold in terms of their derivatives activity”. Exempting end-clients would avoid imposing a heavy compliance burden on relatively small OTC derivatives users that typically rely on their dealers to calculate Simm in any case.

Final text emerging?

The proposed Spanish compromise Emir 3.0 text is dated September 13. The Spanish presidency of the council took charge of the negotiations when Sweden’s term finished at the start of July.

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The Spanish text would subject “only financial counterparties that are most active in OTC derivatives not cleared by a central counterparty” to the new requirement. It would also assign the EBA a central co-ordinating role in the eurozone area over industry-wide models. The EBA would sign off on Simm model validation, calibration, design and instrument coverage, ensuring the industry faces consistent supervisory expectations across the EU.

Council meetings are confidential, but Risk.net understands the Spanish presidency’s wording on this issue received little opposition from member states in the most recent Emir working group, which took place on September 20.Industry sources are therefore confident this will be close to the Council’s final position.

Parliament halfway there

The parliamentary rapporteur on Emir 3.0, Danuta Hubner of the European People’s Party, opposed the EC’s plan to delete the validation mandate altogether. Members of the European Parliament from the Social Democrat and Green groupings also wanted the mandate reintroduced, and laid down amendments that did not specify which regulatory authority would oversee Simm validation.

European Parliament

Danuta Hubner, European People’s Party

Hubner has drafted a compromise text, dated September 19and seen by Risk.net, which explicitly grants the EBA a central co-ordinator role. However, her proposal omitted discussion of the scope of application. A further text dated October 9 defines the scope as firms that are “particularly active in uncleared OTC derivatives”.

This is slightly broader than the Council’s text, and could be deemed to include large non-bank investment firms, rather than just dealers. However, two sources are cautiously optimistic that the Parliament will ultimately accept the Council’s position on both aspects of the Simm validation issue – the EBA’s role overseeing the process, and the application to dealers only. The sources believe there is no political interest among the parliamentary groups in extending the scope of the RTS to include comparatively small OTC derivatives users.

“Those two elements really do help the industry – it may not get them there entirely, but it’s positive,” says a derivatives lawyer.

MEPs are due to vote on November 9 on a final negotiating position ahead of trilogue discussions with the council and EC. Trilogue negotiations are expected to start in either December 2023 or January 2024.

Update, October 17, 2023: New information on the European Parliament’s negotiating position was added as an update at the end of the article.

Editing by Philip Alexander