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B3: Managing derivatives in a complex environment and European Market Infrastructure Regulation (EMIR). Speakers: Henrietta Podd Head of Advice and Origination Canaccord Genuity Peter Moore Assistant Director of Corporate Finance Circle Housing Group Chair: Joseph Carr

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slide1

B3: Managing derivatives in a complex environment and European Market Infrastructure Regulation (EMIR)

  • Speakers: Henrietta Podd
  • Head of Advice and Origination
  • Canaccord Genuity
  • Peter Moore
  • Assistant Director of Corporate Finance
  • Circle Housing Group
  • Chair: Joseph Carr
  • Policy Leader
  • National Housing Federation
interest rate derivatives
Interest rate derivatives
  • The good, the bad and the ugly
  • 23 October 2013
interest rate derivatives1
Interest Rate Derivatives
  • Derivatives have served Housing Associations well
  • Derivatives are incredibly useful tools in the Treasurer’s box of tricks
  • increase financial flexibility allowing a borrower
  • to limit risk absolutely, to limit downside or take a managed view on rates
  • to separate from funding decisions from views on rates
  • to exploit arbitrages
  • allow for the management of specific risks
      • The absolute exposure to moves in interest rates in terms of a mix of fixed and floating debt
      • Adjusting the sensitivity of a portfolio to moves in interest rates in terms of duration
  • can be procured through a competitive process
  • with more counterparties than in the loan market
interest rate derivatives2
Interest Rate Derivatives
  • The Good…. But increasingly expensive
  • Standalone derivatives, so long as they are not over complex, are also transparent
  •  Can be independently valued and priced
  • May have a fixed cost
  • Have a secondary market value
  • Subject to standard termination terms
  • Can be assigned to other counterparties
  • However,
  • In the case of swaps, are likely to be subject to collateral calls
  • Are, of course, subject to hedge accounting
  • Are subject to radical regulatory change
  • And have become very expensive to transact
interest rate derivatives3
Interest Rate Derivatives
  • The “not as good as we thought they were”
  • Most of the derivatives that HAs entered into were pre-2008 and were embedded as part of the loan agreement
  • Fixed or index linked borrowers still have contingent exposure to derivatives
  • These may be less flexible and less transparent than standalone contracts – consequently more difficult to manage
  • The banks have a legacy swap problem just as they have a legacy loan problem
  • Assymetriccollateral agreements
          • Underestimated mark to market exposure
          • Mis-priced credit exposure
          • Underprovisioning due to upfronting excessive profits
  • New regulation and risk models demanding increased capital allocation

They will offer you a deal…

interest rate derivatives4
Interest Rate Derivatives
  • Good friends
  • The bank may offer to:
  • Terminate the swap
  • this will lead to the crystallisation of the Banks mark to market cost which will be recharged to the borrower as a lump sum
  • Restructure the loan with the swap
  • this may spread the mark to market cost over a number of years - at a cost in terms of margin (as the bank is now lending more) and almost certainly a reduction in tenor
  • Dis-embed the swap
  • either to terminate the swap and leave the loan in place or
  • if permitted under treasury policy, become subject to an ISDA

However, most HAs do not have sufficient surpluses to absorb the cancellation costs

simple interest rate swaps and caps
Simple interest rate swaps and caps
  • More virtues than vices

Simple interest rate swaps are extremely useful for Treasurers in reducing risk

Business plans can be effectively de-risked by using short term derivatives to lock in rates

For those able to use standalone swaps, derivatives can be overlaid to manage some of the embedded fixes which are no longer fit for purpose

In particular, over hedging where borrower has forward starting swaps which are no longer necessary

ameliorating mark to market with fixed to floating swaps.

However, there are still challenges

Collateral

Accounting

Reporting

more complex interest rate swaps
More complex interest rate swaps
  • Vicious or just ugly?
  • Complex derivatives often have a purpose beyond reducing interest rate risk
  • The most obvious are using complex derivatives to reduce interest cost – usually by selling an option
  • Others are trying to manage cashflows by cutting cash debt service costs – using accreting swaps, increasing gearing
  • These swaps can move in unexpected ways
  • This means they are extremely difficult to value and often only the bank that wrote them
  • can unwind them
  • However, it may be in the interests of both the Bank and the borrower to exit the position:
  • Atransaction was arranged earlier this year to transfer an inflation swap with a punitive break clause to a pension fund
              • The swap was restructured helping the utility
              • The bank removed it from its balance sheet and
              • pension fund received a 150bps premium over the credit risk of the utility for taking he swap.
              • The pension fund was advised by investment adviser Redington
collateral
Collateral
  • Collateral
  • Risk mitigation through Collateral
    • One way CSAs
    • Thresholds
    • Cash, cash equivalent and property
  • New counterparties
    • Exchanges
    • Institutional investors
  • Bilateral vs OTC derivatives
    • Opportunities offered by exchange traded derivatives
    • Changes to credit risk and collateral
    • Transparent and competitive

HCA: Derivatives and collateral calls - cash and property Mar 2013

LHS shows the MTM liability owed by HAs to banks on IR derivatives , split between unsecured threshold, property and cash collateral, except prior to Sept 2011 when only collateral shown. RHS shows 15 years swap as proxy for the average term of sector’s IR derivatives

emir where did it all start
EMIR – where did it all start
  • G­20 leaders made a commitment in Pittsburgh in September 2009 that:
  • All standardised OTC derivative contracts should be traded on exchanges or electronic trading platforms, where appropriate, and cleared through central counterparties by end-2012 at the latest. OTC derivative contracts should be reported to trade repositories. Non-centrally cleared contracts should be subject to higher capital requirements. We ask the Financial Stability Board and its relevant members to assess regularly implementation and whether it is sufficient to improve transparency in the derivatives markets, mitigate systemic risk, and protect against market abuse.
emir introduces
EMIR introduces:
  • Reporting obligation for OTC derivatives
  • Clearing obligation for eligible OTC derivatives
  • Measures to reduce counterparty credit risk and operational risk for bilaterally cleared OTC derivatives
  • Common rules for central counterparties (CCPs) and for trade repositories
  • Rules on the establishment of interoperability between CCPs

EMIR applies to:

  • To all types and sizes of EU entities that enter into any form of derivatives contract
  • Even indirectly to non-EU firms trading with EU firms.
so what does this mean
So, what does this mean?

All derivatives trades, both exchange-traded and OTC, must be reported to a Trade Repository

  • All trades, including all intra-group, but excluding embedded derivatives
  • Backdated from 16 August 2012

OTC derivatives: minimum set of information to be provided

  • Unique Trade Identifiers (UTI) – Unique global trade ID
  • Legal Entity Identifiers (LEI) – Identification of counterparties
  • Universal/Unique Product Identifiers (UPI) – a globally agreed product identifier
  • Valuation – MtM valuation required on cleared OTC contracts
  • Collateral – information on exposures including collateral valuation and currency
  • In total 85 data fields could be required
so what did this mean for circle
So, what did this mean for Circle?

Our Structure and the issue this created

Circle Housing Group

Circle Anglia Limited (parent)

Registered Providers

x9

Banks

Funding SPV

so what did this mean for circle1
So, what did this mean for Circle?

7 November 2013

ESMA Publish List of TRs

30 August 2013

Pre-LEI (IEI) codes issued &

Co-signed TriOptima’s TriResolve QuickPort

15 Sept 2013

EMIR Portfolio Reconciliation and Dispute Resolution

12 February 2014

All Asset Class Reporting Start Date

July 2013

Started EMIR project

9 September 2013

Completed EMIR Portfolio Reconciliation

15 March 2014

EMIR Reconciliation of uncollateralised, collateralised and intercompany derivatives

August 2013

TR selection process

October 2013

Sign up to UnaVista TR

what we have done since implementation
What we have done since implementation

EMIR Portfolios Reconciliation and Dispute Resolution

  • Reviewed ISDA protocol
  • Identified Counterparty classification; Non-Financial Counterparty (NFC-)
  • Portfolios Reconciliation; Portfolio data receiving entity
  • Dispute identification and resolution procedure
  • - Signed up to TriOptima’s TriResolve QuickPort; Circle Anglia Treasury Limited
  • - Set up an email for future communication
  • EMIR Reporting
  • A Trade Repository (TR) selection process; UnaVista vs. REGIS-TR
  • Issued pre-Legal Entity Identifier (pre-LEI) codes
  • Set up the Mark-to-Market (MtM) valuation via Bloomberg
  • Reconciled all the trades we had since 16 August 2012
slide18

Thanks for listening!

  • Any questions?