Where are we?
On 9 March 2016, the Joint Committee of the European Supervisory Authorities (ESAs) published the final draft regulatory technical standards (the RTS) outlining the framework on margining of uncleared OTC derivatives. The RTS reflect the minimum global standards for margin requirements for non-centrally cleared OTC derivatives introduced by the Basel Committee on Banking Supervision (BCBS) and the International Organisation of Securities Commissions (IOSCO) in September 2013 (and then revised in March 2015). In a nutshell, the RTS:
- set out a requirement for In-scope Counterparties to exchange initial and variation margin (unless exempt);
- outline the list of eligible collateral for the exchange of margin, the criteria to ensure the collateral is sufficiently diversified (with concentration limits only applicable to initial margin) and the methods to determine appropriate haircuts; and
- prescribe the operational procedures related to documentation, legal assessments of the enforceability of the relevant arrangements (such as the bilateral netting agreements) and the timing of the collateral exchange.
The final draft must be endorsed by the European Commission and then accepted by the European Parliament and the Council and published in the Official Journal of the EU before it takes effect. Since publication of the RTS, it has become apparent that the RTS will almost certainly be subject to further amendments, although the nature of these amendments is not clear at this moment. Any changes to the RTS should, therefore, be monitored.
The new margin rules will impact only uncleared OTC derivatives which are entered into between In-scope
Counterparties after the relevant phase-in dates. There has been a delay to the date on which the new margin rules will come into force. The new margin rules are now expected to come into force in the middle of 2017 (the exact date has not been finalised at the date of this publication). It is, therefore, unclear at this stage as to extent of the impact that this will have on each of the various phase-in dates for initial margin and variation margin.
Irrespective of this delay, it is still expected that separate timescales will apply with respect to collateral in the form of initial margin and variation margin (in each case, based on In-scope Counterparties’ aggregate month end average no notional amount of non-centrally cleared OTC derivatives (AANA)). The indicative phase-in periods are as follows:
In-scope Counterparties with an AANA(on a group level) Phase-in date
> EUR 3.0 trillion To be confirmed (originally scheduled to
be 1 September 2016, but likely to be
delayed until mid-2017)
> EUR 2.25 trillion To be confirmed (originally scheduled to
be 1 September 2017)
> EUR 1.5 trillion To be confirmed (originally scheduled to
be 1 September 2018)
> EUR 0.75 trillion To be confirmed (originally scheduled to
be 1 September 2019)
> EUR 8 billion * To be confirmed (originally scheduled to
be 1 September 2020)
*(ie, no In-scope Counterparties below this threshold will be subject to an obligation to exchange initial margin)
In-scope Counterparties with an AANA(on a group level) Phase-in date
> EUR 3.0 trillion To be confirmed (originally scheduled
to be 1 September 2017, but likely to
be delayed until mid-2017)
All other In-scope Counterparties To be confirmed (originally scheduled
to be 1 March 2017, but likely to be
delayed until mid-2017 at the earliest)
The risk management procedures will apply throughout the life of any OTC derivatives that are subject to the margin rules at their respective inception dates. Collateral arrangements relating to non-centrally cleared OTC derivatives entered into before the relevant phase-in date will remain subject to existing bilateral agreements.
The RTS provide for a number of opt-outs which are broadly in line with the previous proposals. The “new” requirements include, among other things (i) an option for In-scope Counterparties to agree on separate minimum transfer amounts for initial and variation margin; (ii) an obligation to take into account (albeit once only) all intra-group non-centrally cleared OTC derivatives of the group for the purposes of calculating the group AANA (in order to determine if the prescribed threshold for collecting initial margin has been exceeded); (iii) an option for an In-scope Counterparty not to collect initial margin where both counterparties belong to the same group and the sum of all initial margin required to be collected by such In-scope Counterparty is equal to or lower than EUR 10 million; and (iv) an option for an In-scope Counterparty not to post or collect margin for OTC derivatives with counterparties domiciled in the third-country jurisdictions if certain conditions are met(suggesting that legal enforceability of netting agreements or collateral protection may not be guaranteed).
To the extent they have not already done so, In-scope Counterparties that may be subject to the margining obligation should now start to take steps to establish when the relevant requirements will apply to them and what they need to do to comply.
Crucially, existing collateral agreements should be scrutinised. To facilitate the implementation of the new margin rules across jurisdictions, the International Swaps and Derivatives Association, Inc. (ISDA) has set up a WGMR Implementation Program. A documentation initiative has been established as part of this program to develop new industry standard documentation to govern collateral and segregation relationships in line with the new margin requirements.
On 29 April 2016, ISDA published the English law Credit Support Annex (CSA) for variation margin. On 15 July 2016, ISDA also published a consultation draft of the ISDA 2016 Variation Margin Protocol (VM Protocol) to assist In-scope Counterparties with the creation of new regulatory compliant variation margin CSAs or upgrade of existing CSAs to be regulatory compliant.
The VM Protocol presents In-scope Counterparties with multiple options as to how to create new CSAs or update their existing CSAs. In order to use the VM Protocol, In-scope Counterparties should have a firm understanding of the CSAs they currently have in place with all of their counterparties. In-scope
Counterparties will also be free to update their CSA arrangements on a bilateral basis, although if a party has a relatively large number of trading relationships, it is expected that the VM Protocol will offer significant efficiencies. ISDA is also developing a self-disclosure letter relating to margining that will provide market participants with a standard form for providing In-scope Counterparties with information to determine whether compliance with initial or variation margin is required and when.
ISDA is also developing a suite of documentation to address requirements for In-scope Counterparties to post initial margin. These documents represent a greater departure from existing ISDA documentation as EMIR requires that each party separately post initial margin that is not netted off and not delivered on a title transfer basis. Both pools of initial margin will be held by the In-scope Counterparties in segregated accounts. Because of the phase-in requirements for initial margin, the initial margin requirements will impact far fewer market participants than the variation margin requirements and many In-scope Counterparties will never be required to post initial margin.
In addition, as part of the program there is an initiative focusing on the creation of a model for the calculation of initial margin (the ISDA Standard Initial Margin Model (the SIMM)). Latest draft documentation relating to the SIMM was published on 3 June 2016. The SIMM aims to provide an open, transparent, standard calculation methodology that will be available to all market participants (and there will be no charge for market participants to use the SIMM to calculate initial margin with respect to their own uncleared OTC derivatives). In-scope Counterparties should be considering the appropriate method for calculating initial margin, as well as overall infrastructure which will be required by then to comply with the new requirements