Margin period of risk ('MPOR'), also known as the "liquidation period" stands for the time period from the most recent exchange of collateral covering a netting set of financial instruments with a defaulting counterparty until the financial instruments are closed out and the resulting market risk is re-hedged (see for example Recital 20 of the draft Commission Delegated Regulation supplementing Regulation (EU) No 648/2012 on OTC derivatives, central counterparties and trade repositories of the European Parliament and of the Council with regard to regulatory technical standards for risk-mitigation techniques for OTC derivative contracts not cleared by a CCP (attached to the ESAs' Second Consultation on margin RTS for non-cleared derivatives of 10 June 2015 (JC/CP/2015/002)),
MPORs are differentiated with respect to OTC derivative contracts and financial instruments other than OTC derivatives.
Article 1(8) of the Commission Delegated Regulation (EU) No 153/2013 of 19 December 2012 supplementing Regulation (EU) No 648/2012 of the European Parliament and of the Council with regard to regulatory technical standards on requirements for central counterparties defines the 'liquidation period' as 'the time period used for the calculation of the margins that the CCP estimates necessary to manage its exposure to a defaulting member and during which the CCP is exposed to market risk related to the management of the defaulter's positions'.
Considering MPOR the particular attention should be given to Article 26 of the said Commission Delegated Regulation No 153/2013 of 19 December 2012 (see box below), as it established a regulatory technical standard for the definition of the time horizons for the liquidation period.
Article 26 of the Regulation No 153/2013
Time horizons for the liquidation period
(applying as from 15.06.2016)
1. For the purposes of Article 41 of Regulation (EU) No 648/2012, a CCP shall determine the appropriate time horizons for the liquidation period taking into account the characteristics of the financial instrument cleared, of the type of account in which the financial instrument is held, of the market where the financial instrument is traded, and the following minimum time horizons for the liquidation period:
(a) five business days for OTC derivatives;
(b) two business days for financial instruments other than OTC derivatives held in accounts not meeting the conditions laid down in point (c);
(c) one business day for financial instruments other than OTC derivatives held in omnibus client accounts or in individual client accounts provided that the following conditions are met:
(i) the CCP keeps separate records of the positions of each client at least at the end of each day, calculates the margins in respect of each client, and collects the sum of the margin requirements applicable to each client on a gross basis;
(ii) the identity of all the clients is known to the CCP;
(iii) the positions held in the account are not proprietary positions of undertakings of the same group as the clearing member;
(iv) the CCP measures the exposures and calculates for each account initial and variation margin requirements on a near to real-time basis and at least every one hour during the day using updated positions and prices;
(v) where the CCP does not allocate new trades to each client during the day, the CCP collects the margins within one hour where the margin requirements calculated in accordance with point (iv) are higher than 110 % of the updated available collateral in accordance with Chapter X, unless the amount of the intraday margins to be paid to the CCP is not material on the basis of predefined amount defined by the CCP and agreed by the competent authority, and to the extent that trades previously allocated to clients are margined separately from trades that are not allocated during the day.
2. In all cases, for determining the appropriate time horizons for the liquidation period, the CCP shall evaluate and sum at least the following:
(a) the longest possible period that may elapse from the last collection of margins up to the declaration of default by the CCP or activation of the default management process by the CCP;
(b) the estimated period needed to design and execute the strategy for the management of the default of a clearing member according to the particularities of each class of financial instrument, including its level of liquidity and the size and concentration of the positions, and the markets the CCP will use to close-out or hedge completely a clearing member position;
(c) where relevant, the period needed to cover the counterparty risk to which the CCP is exposed.
3. In evaluating the periods defined in paragraph 2, the CCP shall consider at least the factors indicated in Article 24(2) and the time period for the calculation of the historical volatility as defined in Article 25.
4. Where a CCP clears OTC derivatives that have the same risk characteristics as derivatives executed on regulated markets or an equivalent third country market, it may use a time horizon for the liquidation period different from the one specified in paragraph 1, provided that it can demonstrate to its competent authority that:
(a) such time horizon would be more appropriate than that specified in paragraph 1 in view of the specific features of the relevant OTC derivatives;
(b) such time horizon is at least two business days, or one business day where the conditions laid down in paragraph 1(c) are met.
Article 26 of the Regulation No 153/2013
Time horizons for the liquidation period
(applying till 15.06.2016)
1. A CCP shall define the time horizons for the liquidation period taking into account the characteristics of the financial instrument cleared, the market where it is traded, and the period for the calculation and collection of the margins. These liquidation periods shall be at least:
(a) five business days for OTC derivatives;
b) two business days for financial instruments other than OTC derivatives.
2. In all cases, for the determination of the adequate liquidation period, the CCP shall evaluate and sum at least the following:
(a) the longest possible period that may elapse from the last collection of margins up to the declaration of default by the CCP or activation of the default management process by the CCP;
(b) the estimated period needed to design and execute the strategy for the management of the default of a clearing member according to the particularities of each class of financial instrument, including its level of liquidity and the size and concentration of the positions, and the markets the CCP will use to close-out or hedge completely a clearing member position;
(c) where relevant, the period needed to cover the counterparty risk to which the CCP is exposed.
3. In evaluating the periods defined in paragraph 2, the CCP shall consider at least the factors indicated in Article 24(2) and the time period for the calculation of the historical volatility as defined in Article 25.
4. Where a CCP clears OTC derivatives that have the same risk characteristics as derivatives executed on regulated markets or an equivalent third country market, it may use a time horizon for the liquidation period different from the one specified in paragraph 1, provided that it can demonstrate to its competent authority that:
(a) such time horizon would be more appropriate than that specified in paragraph 1 in view of the specific features of the relevant OTC derivatives;
(b) such time horizon is at least two business days.
The rationale for defining precisely time horizons for the liquidation is that within the liquidation period the central counterparty (CCP) should be able to either transfer or liquidate the position of the defaulting clearing member and have sufficient margins to cover the exposures arising from the transfer or liquidation of the relevant positions (ESMA Discussion Paper of 26 August 2015, Review of Article 26 of RTS No 153/2013 with respect to client accounts (ESMA/2015/1295)).
For OTC derivatives the minimum MPOR standard is five days both in the EU and in the USA. Under the CFTC rules, this corresponds to five days gross under the LSOC (Legally Separated but Operationally Comingled) account structure.
In turn, pursuant to the aforementioned Discussion Paper of 26 August 2015 reasons for ESMA to set a two-day liquidation period as a minimum for all financial instruments except OTC derivatives was due to the fact that ESMA considered that at a minimum the CCP would need two days to either port or liquidate client accounts for instruments other than OTC derivatives, which are generally more liquid and easier to be liquidated than OTC derivatives.
As the above ESMA's Discussion Paper of 26 August 2015 further observes:
"In the context of the debate on the equivalence between the legal and supervisory arrangements for CCPs in the United States of America (USA) and the EU, it emerged that a critical difference between the two regimes is that for US CCPs the minimum liquidation period for financial instruments other than OTC derivatives is only one day, although applied for client accounts on a gross basis, whereas under EMIR the minimum liquidation period is two days, but margin may be provided on a net basis. Under gross margining clearing members must pass to the CCP enough margin to cover the sum of the separate margin requirements for each client's position, with no netting of exposures between clients; whereas under net margining the clearing members need only pass through sufficient margin to secure the net exposure across a set of clients whose positions are held in the same omnibus account, and so the clearing members may retain much of the client margins."
Therefore, the original regulatory technical standards (Commission Delegated Regulation (EU) No 153/2013, which entered into force 15 March 2013) has been amended on 21 April 2016 to introduce the possibility for EU CCPs to margin on a one day gross basis for clients' accounts.
The Commission Delegated Regulation (EU) 2016/822 of 21 April 2016 amending Delegated Regulation (EU) No 153/2013 as regards the time horizons for the liquidation period to be considered for the different classes of financial instruments (OJ L 137, 26.5.2016, p. 1–3), which applies as from 15.06.2016, introduces certain modifications to Article 26 of the said Regulation No 153/2013 to include the possibility for EU CCPs to margin on a one day basis where a set of criteria are met.
The criteria cover, among others, requiring that margins are collected on a gross basis for clients' accounts.
Commission Delegated Regulation of 4.10.2016 supplementing Regulation (EU) No 648/2012 of the European Parliament and of the Council on OTC derivatives, central counterparties and trade repositories with regard to regulatory technical standards for risk-mitigation techniques for OTC derivative contracts not cleared by a central counterparty
(19) In order to safeguard against the case where collateral cannot be liquidated immediately after the default of a counterparty, it is necessary, when calculating initial margin to take into account the time period from the most recent exchange of collateral covering a netting set of contracts with a defaulting counterparty until the contracts are closed out and the resulting market risk is re-hedged. This time period is known as the 'margin period of risk' ('MPOR') and is the same tool as that used in Article 272(9) of Regulation (EU) No 575/2013 of the European Parliament and of the Council3, with respect to counterparty credit risk of credit institutions. Nevertheless, as the objectives of the two Regulations differ, and Regulation (EU) No 575/2013 sets out rules for calculating the MPOR for the purpose of own funds requirements only, this Regulation should include specific rules on the MPOR that are required in the context of the risk management procedures for non-centrally cleared OTC derivative contracts. The MPOR should take into account the processes required by this Regulation for the exchange of margins.
(20) Initial and variation margin should generally be exchanged no later than the end of the business day following the day of execution. However, an extension of the time for the exchange of variation margin is permitted where compensated by an adequate calculation of the MPOR. Alternatively, where no initial margin requirements apply, an extension should be allowed if an appropriate amount of additional variation margin is collected.
(21) When developing initial margin models and when calculating the appropriate MPOR, counterparties should take into account the need to have models that capture the liquidity of the market, the number of participants in that market and the volume of the relevant OTC derivative contracts. At the same time there is the need to develop a model that both parties can understand, reproduce and on which they can rely to resolve disputes. Therefore counterparties should be allowed to calibrate the model and calculate MPOR dependent only on market conditions, without the need to adjust their estimates to the characteristics of specific counterparties. This in turn implies that counterparties may choose to adopt different models to calculate the amounts of initial margin to be exchanged between them, and that those amounts of initial margin may not be symmetrical.
Article 12
Provision of variation margin
1. The posting counterparty shall provide the variation margin as follows:
(a) within the same business day of the calculation date determined in accordance with Article 9(3);
(b) where the conditions in paragraph 2 are met, within two business days of the calculation date determined in accordance with Article 9(3).
2. The provision of variation margin in accordance with paragraph 1(b) may only be applied to the following:
(a) netting sets comprising derivative contracts not subject to initial margin requirements in accordance with this Regulation, where the posting counterparty has provided, at or before the calculation date of the variation margin, an advance amount of eligible collateral calculated in the same manner as that applicable to initial margins in accordance with Article 15, for which the collecting counterparty has used a margin period of risk ('MPOR') at least equal to the number of days in between and including the calculation date and the collection date;
(b) netting sets comprising contracts subject to initial margin requirements in accordance with this Regulation, where the initial margin has been adjusted in one of the following ways:
(i) by increasing the MPOR referred to in Article 15(2) by the number of days in between, and including, the calculation date determined in accordance with Article 9(3) and the collection date determined in accordance with paragraph 1 of this Article;
(ii) by increasing the initial margin calculated in accordance with the standardised approach referred to in Article 11 using an appropriate methodology taking into account a MPOR that is increased by the number of days in between, and including, the calculation date determined in accordance with Article 9(3) and the collection date determined in accordance with paragraph 2 of this Article.
For the purposes of point (a), in case no mechanism for segregation is in place between the two counterparties, those countarparties may offset the amounts to be provided.
3. In the event of a dispute over the amount of variation margin due, counterparties shall provide, in the same time frame referred to in paragraph 1, at least the part of the variation margin amount that is not being disputed.
Article 15
Confidence interval and MPOR
1. The assumed variations in the value of the non-centrally cleared OTC derivative contracts within the netting set for the calculation of initial margins using an initial margin model shall be based on a one-tailed 99 percent confidence interval over a MPOR of at least 10 days.
2. The MPOR for the calculation of initial margins using an initial margin model referred to in paragraph 1 shall include:
(a) the period that may elapse from the last margin exchange of variation margin to the default of the counterparty;
(b) the estimated period needed to replace each of the non-centrally cleared OTC derivative contracts within the netting set or hedge the risks arising from them, taking into account the level of liquidity of the market where those types of contracts are traded, the total volume of the non-centrally cleared OTC derivative contracts in that market and the number of participants in that market.
Article 16
Calibration of the parameters of the model
1. Parameters used in initial margin models shall be calibrated, at least annually, based on historical data from a time period with a minimum duration of three years and a maximum duration of five years.
2. The data used for calibrating the parameters of initial margin models shall include the most recent continuous period from the date on which the calibration referred to in paragraph 1 is performed and at least 25% of those data shall be representative of a period of significant financial stress ('stressed data').
3. Where stressed data referred to in paragraph 2 does not constitute at least 25% of the data used in the initial margin model, the least recent data of the historical data referred to in paragraph 1 shall be replaced by data from a period of significant financial stress, until the overall proportion of stressed data is at least 25% of the overall data used in the initial margin model.
4. The period of significant financial stress used for calibration of the parameters shall be identified and applied separately at least for each of the asset classes referred to in Article 4(1).
5. The parameters shall be calibrated using equally weighted data.
6. The parameters may be calibrated for shorter periods than the MPOR determined in accordance with Article 15. Where shorter periods are used, the parameters shall be adjusted to that MPOR by an appropriate methodology.
7. Counterparties shall have written policies setting out the circumstances triggering a more frequent calibration.
8. Counterparties shall establish procedures for adjusting the value of the margins to be exchanged in response to a change in the parameters due to a change in market conditions. Those procedures shall provide for counterparties to be able to exchange the additional initial margin resulting from that change of the parameters over a period that ranges between one and thirty business days.
9. Counterparties shall establish procedures regarding the quality of the data used in the model in accordance with paragraph 1, including the selection of appropriate data providers and the cleaning and interpolation of that data.
10. Proxies for the data used in initial margin models shall be used only where both of the following conditions are met:
(a) available data is insufficient or is not reflective of the true volatility of an OTC derivative contract or portfolio of OTC derivative contracts within the netting set;
(b) the proxies lead to a conservative level of margins.
Draft Commission Delegated Regulation supplementing Regulation (EU) No 648/2012 on OTC derivatives, central counterparties and trade repositories of the European Parliament and of the Council with regard to regulatory technical standards for risk-mitigation techniques for OTC derivative contracts not cleared by a CCP
(attached to the ESAs' Second Consultation on margin RTS for non-cleared derivatives of 10 June 2015 (JC/CP/2015/002)
Recital 20
The concept of margin period of risk ('MPOR') is the same as that used in Article 272(9) of Regulation (EU) No 575/2013; as such, MPOR refers to the 'time period from the most recent exchange of collateral covering a netting set of OTC derivative contracts with a defaulting counterparty until the OTC derivative contracts are closed out and the resulting market risk is re-hedged'. Nevertheless, as the objectives of the two Regulations differ, and Regulation (EU) No 575/2013 sets out rules for calculating the MPOR for the purpose of own funds requirements, this Regulation should include appropriate rules on the MPOR that are required in the context of the risk management procedures in non-centrally cleared OTC derivatives. The MPOR should take into account the typical settlement cycle applied to exchange of the margins. This Regulation assumes that both initial and variation margin are exchanged by the end of the following business day. If counterparties agree to a extended settlement cycle for exchange of margins, any extension beyond the the following business day should be included in the calculation of the MPOR.
Recital 21
When developing initial margin models and when estimating the appropriate MPOR, counterparties should take into account the need to have models that capture the liquidity of the market, the number of participants in that market and the volume of the relevant OTC derivative contracts. At the same time there is the need to rely on a model that both parties can understand, reproduce and on which they can rely to solve disputes. Therefore counterparties should be allowed to calibrate the model and estimate MPOR dependent only on market conditions without the need to adjust their estimates to the characteristics of specific counterparties. This in turn implies that counterparties may choose to adopt different models to calculate the initial margin from each other, and that the initial margin requirements are not symmetrical.
Article 2 MRM - Confidence interval and risk horizon
1. In order to qualify for the purposes of Article 1 EIM, the assumed variations in the value of the contracts in the netting set for the calculation of initial margins using an initial margin model shall be based on a one-tailed 99 percent confidence interval over a margin period of risk of at least 10 days.
2. The margin period of risk of a netting set for the calculation of initial margins using an initial margin model shall include:
(a) the period that may elapse from the last collection of variation margin to the default of the counterparty;
(b) the estimated period needed to replace the OTC derivative contracts or hedge the risks taking into account the level of liquidity of the market where that type contracts or risks are traded, the total volume of the OTC derivative contracts in that market and the number of participants in that market.
Final Draft Regulatory Technical Standards of 8 March 2016 on risk-mitigation techniques for OTC-derivative contracts not cleared by a CCP under Article 11(15) of Regulation (EU) No 648/2012 (document of the Joint Committee of European Supervisory Authorities (ESAs): the European Banking Authority (EBA), the European Insurance and Occupational Pensions Authority (EIOPA) and the European Securities and Markets Authority (ESMA), ESAs 2016 23)
Recital 23
In case that collateral cannot be liquidated immediately after default, it is necessary to take into account the time period from the most recent exchange of collateral covering a netting set of OTC derivative contracts with a defaulting counterparty until the OTC derivative contracts are closed out and the resulting market risk is re-hedged, which is known as 'margin period of risk' ('MPOR') and is the same tool as that used in Article 272(9) of Regulation (EU) No 575/2013 of the European Parliament and of the Council3. Nevertheless, as the objectives of the two Regulations differ, and Regulation (EU) No 575/2013 sets out rules for calculating the MPOR for the purpose of own funds requirements only, this Regulation should include specific rules on the MPOR that are required in the context of the risk management procedures for non-centrally cleared OTC derivatives. The MPOR should take into account the processes required by this Regulation for the exchange of margins. Normally, both initial and variation margin are exchanged no later than the end of the following business day. An extension of the time for the exchange of variation margin could be compensated by an adequate rescaling of the MPOR. Therefore, taking into account possible operational issues, it should be allowed to extend the time for the exchange of variation margin where such an extension is included in the rescaling of the MPOR. Alternatively, where no initial margin requirements apply an extension is allowed if an appropriate amount of additional variation margin has been collected.
Recital 24
When developing initial margin models and when estimating the appropriate MPOR, counterparties should take into account the need to have models that capture the liquidity of the market, the number of participants in that market and the volume of the relevant OTC derivative contracts. At the same time there is the need to develop a model that both parties can understand, reproduce and on which they can rely to solve disputes. Therefore counterparties should be allowed to calibrate the model and estimate MPOR dependent only on market conditions, without the need to adjust their estimates to the characteristics of specific counterparties. This in turn implies that counterparties may choose to adopt different models to calculate the initial margin, and that the initial margin requirements are not symmetrical.
Article 17 Confidence interval and margin period of risk
1. The assumed variations in the value of the contracts in the netting set for the calculation of initial margins using an initial margin model shall be based on a one- tailed 99 percent confidence interval over a MPOR of at least 10 days.
2. The MPOR of a netting set for the calculation of initial margins using an initial margin model shall include:
(a) the period that may elapse from the last margin exchange of variation margin to the default of the counterparty;
(b) the estimated period needed to replace the OTC derivative contracts or hedge the risks taking into account the level of liquidity of the market where that type contracts or risks are traded, the total volume of the OTC derivative contracts in that market and the number of participants in that market.
Documentation
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Collateral requirements under EMIR
Client segregation and portability under EMIR