International Regulators Publish "Near-Final" Draft of Uncleared Swap Margin Rules
On February 15, the Bank for International Settlements (BIS) and the International Organization of Securities Commissions (IOSCO) published the Second Consultative Document on margin requirements for non-centrally cleared derivatives.
The document sets out the “near-final” international policy framework for margining derivative transactions that are not cleared through a central counterparty (CCP). The framework is needed in order to coordinate the individual responses of the G20 nations to their commitment to introduce mandatory initial and variation margin rules as part of their program to reduce systemic risk from uncleared over-the-counter derivatives. Although the US swap regulators have previously proposed their own margin requirements for derivatives under Title VII of the Dodd-Frank Wall Street Reform and Consumer Protection Act, it is expected that those proposals will be modified to be substantially consistent with the final international policy framework.
The key elements of the BIS-IOSCO approach can be summarized as follows:
Initial and variation margin should apply to all derivative transactions that are not cleared by CCPs except for physically settled foreign exchange (FX) forwards and swaps.
- Margin rules should apply only to financial firms and systemically important non-financial entities (Covered Entities), but not other entities.
Covered Entities can agree on a threshold of up to €50 million for exchange of initial margin. The threshold for variation margin is zero.
A Covered Entity is exempt from initial margin requirements if the gross outstanding notional amount of its swap portfolio (measured on a rolling basis) is less than €8 billion.
Initial margin may be calculated by reference to (a) a margin model approved by relevant regulators, or (b) a standard schedule that, for example, requires initial margin equal to 1% of notional for an interest rate swap with a duration of less than two years and 4% of notional for a swap with a duration of more than five years. Initial margin can be adjusted by an amount that relates to the net-to-gross ratio pertaining to derivatives subject to a legally enforceable netting arrangement.
Initial margin must be exchanged by covered entities on a gross, two-way basis and must be held in a manner that protects the posting party from the insolvency of the collecting party.
Exemptions for swaps with affiliates are left to national regulation.
- Covered entities in different countries with comparable margin rules can agree which set of rules will apply.
The rules for variation margin will not come into effect until January 1, 2015. The rules for initial margin will be phased in starting in 2015 based on the notional amount of swaps executed in the last three months of 2014. Full implementation may not occur before 2019.
- All swaps executed prior to 2015 will be grandfathered.
Comments must be submitted by March 15, 2013, and have been specifically requested with respect to the following four issues:
the treatment of physically settled FX forwards and swaps under the framework;
the ability to engage in limited re-hypothecation of collected initial margin;
the proposed phase-in framework; and
- the adequacy of the related quantitative impact study.
The full text of the Second Consultative Document can be found here.