Clearing and margin

The European Market Infrastructure Regulation ("EMIR")1 imposes a number of risk mitigation techniques on counterparties to uncleared swaps. Some of those involve much tighter operational procedures (such as the rules for timely confirmations, portfolio reconciliation and dispute resolution). However, the most significant increase in the costs of trading over-the-counter ("OTC") derivatives will arise as a result of the rules on margin and eligible collateral for such trades. New legal and risk issues will need to be addressed in the running of what will become multiple collateral posting flows: for initial margin ("IM"), for variation margin ("VM"), possibly with silos for different currencies and different jurisdictions and separately, for legacy trades pre-dating the new rules (each separate from cleared trades).

The latest consultation paper (the "Consultation Paper") on draft regulatory technical standards ("RTS")on risk-mitigation techniques for OTC derivatives contracts not cleared by a central counterparty2, published by the three European Supervisory Authorities ("ESAs")3: (i) prescribes the minimum amount of IM and VM to be posted and collected and the calculation methodologies to be used; (ii) specifies the eligible collateral, (iii) stipulates certain thresholds to be applied to the posting of collateral, (iv) provides the permissible methods to calculate margin and (v) dictates a number of written agreements for inclusion of counterparties' risk management policies.

Market participants may comment on the impact of the RTS until 14 July 2014.

To whom does the RTS apply?

Counterparties are required to collect collateral if they are financial counterparties ("FC") or non-financial counterparties above the clearing threshold ("NFC+").

Excluded from the scope of the RTS are: (i) non-financial counterparties below the clearing threshold ("NFC-"), (ii) members of the European System of Central Banks and other Member States' bodies performing similar functions and other EU public bodies charged with or intervening in the management of the public debt, (iii) the Bank for International Settlements; (iv) the central banks and public bodies charged with or intervening in the management of the public debt; (v) multilateral development banks; (vi) public sector entities where they are owned by central governments that have explicit guarantee arrangements provided by central governments, and (vii) the European Financial Stability Facility and the European Stability Mechanism.

Are there exceptions for IM for certain types of derivatives?

Yes, for IM relating to (i) physically settled foreign exchange forwards, (ii) physically settled foreign exchange swaps and (iii) the principal exchange of currency swaps.

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