Central counterparties (CCPs) have always been a controversial issue in the securities lending market.
However, thanks to the European Securities and Markets Authority’s (ESMA’s) regular consultations with industry participants, one prickly area may be on the path to becoming somewhat smoother—that of conflicts of interests under the European Market Infrastructure Regulation (EMIR).
Eight industry stakeholders, including Eurex Clearing and the London Stock Exchange, weighed in on the issue, which some argue has been neglected somewhat in existing regulatory frameworks.
An ESMA consultation paper, released in June, says EMIR “only prescribes generic provisions in relation to the management by CCPs of conflicts of interest”. The authority proposes giving further guidance to CCP’s management to “ensure common, uniform and consistent application” of the EMIR guidelines, which were first introduced in December 2012 under EU legislation.
As part of its CCP college activity, and given that ESMA is a member of all CCP colleges, ESMA claims to have a “horizontal view” on how all EU CCPs have implemented these requirements.
The consultation was intended to identify and manage any potential conflicts of interest between a CCP and its clearing members, as well as to identify areas in which CCPs may not be sufficient to withstand risks of damage to the interests of a clearing member or client.
ESMA guidelines firstly define what constitutes a conflict of interest, and what should be the scope of a CCP’s policy regarding the issue. Secondly, the guidelines describe the organisational arrangements CCPs should take in order to avoid or mitigate conflicts of interests.
The paper was put to the industry with ESMA asking whether respondents consider the proposed rules of conduct “appropriate to limit the risks of conflicts of interest”.
A particular point of contention appears in paragraph 26 of the consultation, which points to rules limiting the number of additional contracts or mandates a board member or executive director of a CCP can have.
It also outlines requirements that CCPs should not appoint external auditors that have links with that CCP, and that “an employee which intends to perform any outside activity potentially conflicting with the responsibilities undertaken at the CCP seeks the CCP pre-approval before accepting the new engagement for another entity”.
Deutsche Boerse subsidiary Eurex Clearing, which serves more than 180 clearing members in 17 countries, says: “The proposed rules of conduct [are] appropriate.”
The response continues: “For potential conflicts of interest with external auditors, there are already sufficient requirements in regulation and transpositions into national law in place.”
However, Eurex Clearing did recommend some additional requirements for consideration.
It says: “In order to prevent misinterpretations of the term ‘external audits having a link with or receiving benefit from the CCP’, we propose adding a reference to the existing rules or deleting this specific requirement.”
The European Association of CCP Clearing Houses (EACH) also says it considers the proposed rules to be “generally appropriate”.
EACH says: “It is in the interest of a CCP to have board members that allow representation on a group board level or in other subsidiaries, taking rules of conduct into account. As CCPs are often part of a bigger corporate group, group mandates are common and have proven to work effectively, including with possible conflicts of interest being appropriately managed.”
However, the association recommended clarifying the rules around the limitations of the number of contracts or mandates board members and executive directors may take on.
It says: “A very strict and quantitative limitation would impair the ability of a CCP to attract highly-qualified and experienced managers and board members from group level. This could be problematic, taking into account that some CCPs are active in niche markets where specific expertise and deep knowledge is highly necessary.”
BME Clearing went as far as suggesting complete deletion of this measure, saying in its response: “The limitation of the number of contracts or mandates of board members and executive directors is not reasonable.”
It continues “This limitation is established for listed companies
with the aim of assuring time availability and commitment of their board members.”
“External auditor appointment is already regulated in the directive on statutory audits of annual accounts and consolidated accounts.”
The London Stock Exchange (LSE) wanted to slightly revise the rules, to add that CCP staff members should have an understanding of potential areas of conflicts of interest, and the provision that staff must “comply with any appropriate mitigating actions which may be required by the CCP in the circumstances”.
It added that rules to limit contracts and mandates for board members “is not mandatory to appropriately mitigate the risk of conflict of interests”.
“Independence is a quality that can be possessed by individuals, and is an essential component of professionalism and professional behaviour. The fact that a board member performs more than one role in one company does not necessarily affect, in itself, the objectivity of [their] decisions.”
Paris-based asset manager Amundi requested more explanation within the proposals, focusing particularly on the issue of the scope of the proposed rules, asking for clarification as to what level of staff the regulation concerns.
The response says: “We would recommend to determine a category of ‘concerned staff’ and not apply blindly the same level of requirement for all employees.”
“The proposed guidelines should be limited to this concerned staff.”
It also asks: “Does it cover the case of a future employment and, consequently, does it imply to introduce costly limitations in the possibility for a staff member to join a competing or potentially conflicting entity?”
Amundi concludes: “If it only aims at preventing simultaneous dual employment we agree, if not we see an issue on the cost involved and the risk for future litigation.”
Taking a stronger stance, European Commodity Clearing (ECC) said it “strongly opposes a limitation of the number of contracts or mandates board members and executive directors can have”.
It says: “Such a limit would be even more problematic for CCPs active in niche markets where profound expertise and knowledge of the exchange side is highly necessary.”
The ECC also proposed that, in the “unlikely event” of a possible conflict of interest arising, the board member or employee could potentially be excluded from any related negotiations, decision-making processes, and votes.
These sentiments were echoed by Austria CCP, which also requested clarification around the rules “by including specific limitations”.
Austria CCP’s response adds: “Moreover, in Austria, the Austrian Stock Exchange Act and the Austrian law on companies with limited liability for the limitation of board member mandates in capital companies already exist.”