EUROPE: Joint Association Letter on the use of EEA UCITS as Collateral

Thursday April 22 2021

The Alternative Investment Management Association (AIMA), the Institutional Money Market  Funds Association (IMMFA), the Investment Company Institute (ICI), the International Swaps  and Derivatives Association (ISDA) and the Securities Industry and Financial Markets  Association Asset Management Group (SIFMA AMG) (collectively “the associations”) are writing to urge the Prudential Regulation Authority (PRA) to permit use of European Economic Area (EEA) UCITS for initial margin (IM) purposes in the UK Uncleared Margin Requirements (UMR) Binding Technical Standards (2016/2251) once the current ‘standstill’ comes to an end on 31 March 2022.

Under the EU UMR, financial counterparties are permitted to use EEA UCITS as IM, subject to the conditions set out in Articles 4 and 5 of the EU Margin RTS. The UK UMR have similarly restricted financial counterparties to use of UK UCITS as IM (Article 4 (r)).

The impact of this restriction is postponed by the ‘standstill’ approach adopted under UK rules, whereby UK counterparties do not have to adapt current procedures and arrangements for exchange of margin in uncleared derivatives business until 31 March 2022.

The associations believe, however, that once the restriction to use of UK UCITS as IM is in effect, there will be negative consequences for the counterparties concerned and for the attractiveness of the UK as a jurisdiction in which to do uncleared derivatives business. This limitation is also not justified on risk grounds.

Derivatives counterparties may need or prefer to use UCITS (particularly MMFs) as IM

Derivatives counterparties, including UCITS managers and investment managers may use UCITS as IM. In the case of funds, this may be more efficient than (as applicable) having their depository or custodian reinvest cash into UCITS MMFs, for several reasons, including:

• The lack of alternative eligible collateral available to the fund’s managers.
• The investment guidelines within which the fund must operate, which may limit the ability to trade other types of eligible collateral.
• Operational limitations on the ability of the fund to trade other types of collateral

The pool of EEA UCITS is much larger than the pool of UK UCITS

In a survey conducted by the IMMFA, it found that just two of 80 funds managed by their members were domiciled in the UK (both sterling funds). The other 78 funds were domiciled in Luxembourg or Ireland.

As such, the pool of IM that is available to asset managers subject to UK UMR appears significantly smaller than that available to EEA asset managers.

Negative impact for the UK as a place to do uncleared derivatives business, in relative and absolute terms

The extra layer of complexity and cost for asset managers (subject to UK rules) engaging in uncleared derivatives business, because of this limitation, will adversely affect the ability of UK asset managers to undertake uncleared derivatives business:

• As stated above, IM in the forms of UCITS will be scarcer, with operational and cost implications.
• This limitation will affect the ability of UK counterparties to trade with EEA asset managers, who may wish to post EEA UCITS as IM. Those EEA counterparties may prefer to choose to trade with other EEA counterparties that can accept EEA UCITS as eligible collateral under the EU Margin RTS (or counterparties from other jurisdictions who are not limited in their ability to accept EEA UCITS as IM).
• Given the size of the pool of UCITS IM available to EU asset managers (many multiples of the size available to UK asset managers), the negative impact on the EU as a location for uncleared derivatives business will be far less significant than the negative impact for asset managers subject to UK UMR. The availability of EEA UCITS is of greater importance to UK asset managers than is the availability of UK UCITS as IM for EU asset managers.

Restricting the ability of UK counterparties to using only UK UCITS as IM (and not EEA UCITS) is not justified on prudential grounds

EEA UCITS are not inherently riskier than UK UCITS. There will be no deterioration in the quality of collateral provided by counterparties as IM if the UK UMR are amended to permit use of EEA UCITS as IM. On the contrary, the associations believe that such a step would be beneficial to overall market liquidity.

The PRA is currently consulting on amendments to the BTS 2016/2251 and may align UK UMR more closely with the latest iteration of EU UMR at the conclusion of this process. We urge the PRA to take this opportunity to expand the eligibility criteria in the BTS to include EEA UCITS.

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