Following the Central Bank of Irelands recent clarification on breaches of the minimum credit requirement for counterparties and prime brokers in OTC derivatives transactions, Trinity Fund Administrations Peter O Dwyer says the regulator is becoming more mediatory in its approach with financial institutions in the event of such a breach.
The clarification follows the regulators July publication of services of notices and guidance notices, which prescribe minimum credit rating requirements for counterparties to OTC derivative transactions, prime brokerage arrangements and efficient portfolio management techniques including stock lending and repo transactions.
In the case of UCITS, OTC derivatives counterparties which are not banks and all counterparties to repo or stock lending arrangements must have a minimum credit rating of A-2 or equivalent or be deemed by the UCITS to have an implied rating of A-2 or equivalent. Alternatively, an unrated counterparty will be acceptable where the UCITS receives from an entity, which has and maintains a rating of A-2 or equivalent an indemnity or guarantee in res
In the event of a breach of the Central Banks requirements, directors of the investment company/management company and the trustee must remedy that situation over a reasonable timeframe, taking due account of those interests. The director/management company or trustee must continue to actively monitor the credit worthiness of the counterparty by conducting internal ratings assessments on behalf of the investment fund. A decision to remain contracted to a counterparty inadvertently in breach of the Central Banks rating requirements should be supported by an internal rating assessment undertaken on behalf of the investment fund.
ODwyer commented: The Irish regulator has always paid attention to the risk associated with prime broker and counterparty relationships and they put the onus on the fund boards to be responsible for monitoring the risk of those relationships. In the event where the minimum rating is breached they have to remedy that through monitoring and that should become a priority in the event of an inadvertent breach. This happens not infrequently so I suppose there is recognition to do things very quickly to remedy the situation and to fix the relationship.
People have gone about remedying these inadvertent breaches but the regulations covering them have been more formal to date so that institutions get nervous if they dont get the requirements right. Now the Central Banks clarifications encourage more dialogue between counterparties. There is a credible enforcement for breaches.
For fund administrators, the onus is on monitoring and change of relationships with funds, advisors and prime brokers if necessary. This is not an issue for us as we have relationships with more than one prime broker. There has been a transition in Ireland where institutions now are not worried about getting caught up in events such as the downgrades by Moodys and what the regulators reaction might be if the requirements were breached. There is less micromanagement and the new regime will be one of credible risk enforcement, which is good as people dont want to be fined.
(JDC)