ESMA further clarifies custodians' role under contentious EMIR article

EUROPE – The European Securities and Markets Authority (ESMA) has acknowledged the need for clearing houses to outsource some activities to custodian banks when holding non-cash collateral posted by derivatives users such as pension funds with securities settlement systems.

In a document answering industry questions, the Paris-based authority further clarified the stance it would take on certain technical standards for derivatives regulation under the European Market Infrastructure Regulation (EMIR).

Under article 47.3, ESMA recommends that initial margins for derivatives trades be held by securities settlement systems – usually operated by central securities depository (CSD) – that ensure the “full protection” of those financial instruments.

ESMA, in its answer published yesterday, said that clearing houses – also called central counterparties (CCPs) – may sometimes use third party service providers such as custodian banks to manage “certain operational aspects” of accounts that the CCP holds at a securities settlement system.

The authority was responding to a question asked by the industry on whether a CCP could outsource certain operational aspects to third parties.

ESMA also stressed that an answer given in March should not be read as preventing CCPs from the use of such outsourcing arrangements to third parties.

In a previous response, ESMA had already stressed that depositing non-cash collateral posted by end-user clients with a CSD through a custodian did not “constitute a deposit with an operator of a securities settlement system”, as required in Article 47.3.

The new answer provided yesterday would have relieved some of the pressure on CCPs and custodian banks who have argued over the past months that, depending on the strong a stance ESMA were to take with article 47.3, CCPs could be prevented from using tri-party agreements they have put in place to protect their clients’ assets.

Tri-party agreements are arrangements signed between CCPs, custodian banks and pension funds whereby the non-cash securities posted for margin calls by a pension fund to a CCP in centrally cleared derivatives trades be held in segregated account facilities offered by custodians.
 
In an earlier interview with IPE, Andrew Lamb, chief executive at CME Clearing Europe, said: “Article 47 is fine, but we are aware some people could read this article in a narrower sense, meaning clearinghouses do not have the discretion and would be prevented in any circumstance from using collateral safe-keeping arrangements unless those collateral arrangements are provided by CSDs.”