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Initial annex

[Music] of course it was also easy when I started working with derivatives some 22 years ago the mainly agreement I needed to know was this one since the 2002 is the Master Agreement and I dealt with its predecessor at that time the 1992 Master Agreement and all we had to know was this was the framework agreement covering OTC derivatives under it the terms were was set out in a printed main body and amended through a schedule practitioners were able to choose whether English law or New York law applied to it and of course we'd also have to learn about collateral and for that we had the credit support annex and here's one here it's the CSA it's governed by English law which meant it was a title transfer annex and it would be an annex to the as de master agreement and there was also a New York law version of the CSA as well here's one here that would be a security interest document so just knowing those three agreements inside out that were these were your foundation agreements for OTC derivatives occasionally we'd also use the credit support deed this was a security interest document under English law and it was rarely used it was used those special times that margin needed to be segregated perhaps it it also got some increased popularity after the financial crisis and was used by hedge funds who were segregating margin at their prime prime broker but with the margin rules the amount of documentation which underlies one of these is de master agreements has become huge so let's work through how that has expanded with the 2016 variation margin requirements coming in coming into play that meant that affected institutions had to put in place in a dish to their credit support annex which would remain for legacy transactions they also had to put in place a credit support annex for variation margin which complied with the vm rules now have one here here's a version for English law there was another version that was done for New York law so up until initial margin his requirements came into force it was really just this package that derivatives counterparties had to deal with and that's still the case for any derivatives counterparty that has not come into scope of the initial margin rules now understanding that background and those documents has given the shape to why we have such a variation of documents here the margin rules came in under a very tight timeframe in 2016 so the drafters of the margin documentation thought that the best way to meet that would be to adapt the existing is the collateral documentation to make it work with with the new initial margin requirements so one that was possible easily with the credit support annex under New York law because I mentioned the New York law CSA is a security interest document the drafters produced under New York law in 2016 as released by but by by is de the phase one credit support annex for initial margin the 2016 version now if you run a black line against the New York law CSA you can you can see the genesis of it it's a bigger document but it has lots of additional provisions to comply with margin requirements now so that so far so simple credit support annex for initial margin it's based on the CSA everybody's familiar with already and it's in addition to the variation margin CSA so a New York law counterparty now has their master agreement they have the credit support annex for legacy trades they have a 2016 CSA for VM margin as well and now our phase but a phase one counterparty has a CSA for initial margin under New York law and of course that's only going to generally be in place where the underlying assets that are being posted are located in the United States so it is possible to have an CSA on the New York law underlying and is under English law although not hugely common so how as I mentioned the English law CSA is a title transfer document once collateral is posted under an English law CSA the party that's received that collateral owns it so it's a title transfer document well that doesn't work for initial margin because the pet collateral has to be posted and a security interest granted but it remains in the ownership of the party that pledge or who's posted that that collateral so adapting English law CSA isn't going to work - instead what the drafters did for the English law document is they took this the credit support deed drafted in the 1990s rarely used as I said and made that work because it was intended to be used with third party custodians under English law so we now had a credit support deed that was adapted to become the 2016 phase 1 credit support deed for initial margin now that so far so simple we have a credit support annex version for use in the United States where collaterals located in the United States we've got a credit support deed for use of collateral that's located in the UK so with the tri-party agents which are based in the UK such as JP Morgan and BNY Mellon but there were two other tri-party agents prominent in the market Euroclear which was based in Belgium and Clearstream which is based in Luxembourg so the idea of the credit support deed and the credit support annex is that you have a security interest within those documents and that's where Security's taken over the collateral that's posted so you have a New York law security interest that's within the 2016 is to CSA and you have an English law security interest for assets located in the UK under the credit support deed so that's good so that works where you have a custodian such as BNY Mellon and the United States assets located in the United States for the u.s. document the English law document works for the two tri-party agents which substantially had their assets held under custody in the UK should be NY Mellon and JP Morgan again however there are two were two other prominent tri-party agents in the initial margin sphere Euroclear based in Belgium and Clearstream based in Luxembourg so with the assets of Euroclear that they're held in custody being located in Belgium it no longer work to have a security interest under English law because the assets were in Belgium or on the New York law for the same reason so a variation of the credit support deed and credit support annex was created especially for Euroclear and for clearstream so Euroclear and Clearstream version of the credit support team and credit support annex are called the collateral transfer agreement and I have a 2016 version here it's called collateral transfer agreement for use with euro clear bank collateral management documentation for non centrally cleared derivatives I have another version here the 2016 version of the collateral transfer agreement for use with clear stream tri-party collateral management services and the key difference with the English law and the New York lot law versions is that the security interest is stripped out and that's because these documents retain English law as the governing law and they then add in various provisions as well which are specific to Euroclear and Clearstream and add two additional documents which are the security agreements which add the security interest under those respective governing laws so i've got here the 2016 clear stream security agreement and I've got the 2016 Euro clear security agreement these are governed by the local laws of where the s underlying collateral is situated so in the case of the clear stream agreement it's governed by Luxembourg law in the place of the euro clear security agreement it's governed by Belgian law so that tight timeline of bringing in the IIM rules led to adapting those existing documents to credit support the credit support annex then bringing about a new agreement to deal with underlying collateral assets being based in other other legal systems that was fine for the phase one dealers and the phase two dealers the world's largest market making banks for OTC derivatives but in phase three which came in in September 2017 we saw the first by side entity come into scope so one of the world's leading hedge funds and this meant that there was some additional geeks that needed to be made to the margin documentation one of the key ones is that heads of large hedge funds already post margin outside of the I M requirements and it may be something that's more demanding it may be something for prime brokerage requirements or the other assets that are held and some of the tweaks that are made in here and we covered these in some detail in the first episode of series 1 are designed to take account of that as the threshold lowers the range of financial institutions in scope begins to diversify and in 2017 it included the first by side entity estimates vary but with a threshold of 750 billion euros there may be as many as 70 new lien scoped counterparty groups in phase four which commences and comes into force on 1st September 2019 as with earlier phases the phase for counterparty groups will need to enter into I am compliant document sets with paired entities in counterparty groups in their own phase and also earlier phases phase 5 the final phase coming into effect on 1st September 20 20 pounder parties with a gross notional amount of uncleared OTC derivatives at a measurement point above 8 billion euros some estimates placed a number of affected counterparty groups as high as 1,200 that meant in 2018 we had a new series of documents came out so we had a 2018 version of the credit support deed for initial margin a 2018 version of the credit support annex for initial margin and we also had new versions of the Euroclear and Clearstream collateral transfer agreements and in addition because other custodians were beginning to become involved in initial margin a generic version of the CTA was produced in particular taking into account that some of those new custodian may not be based in Belgium may not be based in Luxembourg the UK or the US and so the security interest is stripped out of that document again again it's covered by its governed by English law and separate security agreements could then be added under the governing law of where the collateral assets were located so we had new forms of the Euroclear security agreement we had new forms of the clear stream security agreement so these forms introduced they're able to be taken advantage of by newly unscoped counterparties and it wasn't that the old documents had become obsolete because many phase 1 2 & 3 counterparties were quite happy with the existing set of documents particularly if they weren't facing a hedge fund so we have the 26 documents still being used the 2018 documents are now being used as well so we've got quite a long way in this episode and most of our episodes without mentioning brexit but unfortunately brexit has made everything all the more complicated and the reason for that is because we're a custodian is holding the assets of an EU 27 counterparty that now becomes very problematic because of the rules surrounding brexit so what the tri-party custodians have done who've held assets in the UK have been facing eu27 counterparties they have instead set up hubs within the eu27 so BNY Mellon has established a new hub in Belgium for dealing with eu27 counterparties JPMorgan has done the same in Luxembourg and this has required some amendments to the documentation so we now have a new 2019 generic collateral transfer agreement for initial margin and that can be used by any custodian and there are a number of new custodians coming into the market for phase 5 they've been estimates this could be as many as 50 or 60 new custodians other figures we've heard it's likely to be 12 to 15 maybe maybe a few few more but those custodians may be holding assets in many different countries so we have a new generic CTA collateral transfer agreement that can use be used alternatively to the credit support deed where assets are for non EU 27 clients and that and the custodian retains its hub in the UK and indeed that's that's what's happened where a custodian has also retained a hub in the UK such as BNY Mellon and continues to use the credit support deed with those those clients so we have this new set of agreements in 2019 we have a news version of the CTA for Euro clear a new version of the the CTA for clear stream a new generic CTA and it's picking up on some of these these bricks and issues there that assets may be situated in the EU for EU clients and this has meant meant that we have a whole new series of security agreements that have come out because the CTA not have the security interest within it the collateral transfer agreement is under English law the security agreement is under the law of where the assets are held so we've got all these different drafts of that and that's what we have here so I'm looking here I've got an Irish law version of the security agreement prepared and released by pas de I've got a Luxembourg law security agreement released by ESDA and you might say don't we already have one of those because we have it for Clearstream well this is a non clearstream version we have a French law version here and we have a generic Belgian law version here as well so having gone from that simplicity over here of having just an is the Master Agreement and maybe accredit support annex we have this plethora of other documents and if you're a phase 5 counterparty depending on the custodian of your counterparty you could find yourself using any of these documents it would also depend on the the choice of your counterparty as well it may depend on the number of custodians you are using yourself so this is the whole range of documents that you could end up having in place as a phase 5 counterparty as you prepare to meet the initial margin requirements so what could this mean for Cadiz group as a phase 5 counterparty let's say Cadiz group has appointed BNY Mellon as its custodian for its UK subsidiary well that would mean to this group would enter into a 2018 credit support deed and there'd be no need for a security agreement because the security interest is set out within the credit support deed but let's say for one of Cadiz groups counterparties it was faith at that counterparty had appointed Euroclear as its custodian well that would mean that the Ian would enter into a 20-19 collateral transfer agreement and because the assets were situated in Belgium there would be a euro clear security agreement under Belgian law now for another counterparty that counterparty might have appointed clear stream and so Cadiz group would enter into the 2019 collateral transfer our agreement for clear stream because the under lock the collateral is situated in Luxembourg the capelet because group would also enter into a 20-19 clear stream security agreement let's say Cadiz group was facing an EU 27 counterparty that had appointed BNY Mellon well then it will also have in place with that counterparty be using the generic 2019 collateral transfer agreement and it would be using a form of the Belgian law security agreement for initial margin as well and you can see that there could be various other nuances to that in this group might be facing a phase one counterparty that says thank you very much we still really like the 2016 documentation so we're going to enter into that document so you're going to have a 2016 credit support deed and the variations then start to spread out as perhaps another counterparty has appointed an Irish law custodian so we've got the generic phase 5 CTA we've got an Irish law security agreement as well so there could be 300 documents or so that let's assume across the various counterparty matchings but amongst those 300 documents you could find a big range of documentation now we've been looking at this today from the credit support deeds CT a security agreement perspective we haven't forgotten that there's another level of documentation which would be the account control agreements and the custody agreements and those are going to be specific to the particular custodian that's been appointed and that something that be the subject of another episode and also it's something we covered to to a certain extent in episode 1 of series 1 under the collateral agreement that charge or charges the segregated accounts and any collateral in them in favor of the secured party and assigns the charge or assigned rights to the secured party these assigned rights are defined as all present and future rights relating to the collateral which the charge or has against the securities intermediary or any third party so that's the is de documentation and we talked about English law and New York law and the local laws for the security agreements but there are other governing laws available for initial margin and that's something that could this group would need to consider post or in the run-up to brexit is they launched a project to create an Irish laura's de master agreement and a French law is de master agreements and these have been accompanied by credit support documentation under those laws but also in addition to is de the German banking association has also created German law documentation to support the German law master agreement and German created German law documentation for posting initial margin so when we were in Frankfurt recently I sat down with my partner Patrick Scholl and we discussed the German banking association German law template documentation for I am you