INSIGHTS IN BRIEF: Uncleared Derivatives Margin Reforms
“Life on the Margin” – a 101 guide
In March 2015, the Basel Committee on Banking Supervision (BCBS), part of the Bank of International Settlements (BIS), and the International Organisation of Securities Commissions (IOSCO) finalised a framework to reduce systemic risk by establishing a consistent global standard for margining of non-centrally-cleared derivatives.
These reforms were part of the agenda put in place by the G20 as a response to the 2008 global financial crisis and were intended to reduce systemic risk in non-centrally cleared derivatives by ensuring that appropriate collateral is available to offset losses caused by the default of a counterparty.
Regulators globally are in the process of finalising their rules which will implement the BCBS IOSCO framework. Whilst the margin rules applicable in each jurisdiction are based on the same global policy framework published by BCBS IOSCO, there will be specific differences in each jurisdiction’s requirements.
In short, the uncleared margin rules will require most financial firms and systemically important non-financial firms to exchange Initial Margin (IM) and Variation Margin (VM) when entering into non-centrally cleared derivatives with other covered entities.
- Variation margin is margin exchanged between parties to non-centrally cleared derivatives that covers the day-to-day change in net mark-to-market value of the portfolio of non-centrally cleared derivatives.
- Initial margin is margin posted and collected by parties to non-centrally cleared derivatives that covers each party against the potential future exposure that may arise from changes in the value of the portfolio of non-centrally cleared derivatives in the event of the other party’s default.The new rules will be implemented at various times from 2017 and beyond, depending on the jurisdiction and circumstances of the counterparty. The first key deadline for most counterparties is expected to be 1 March 2017.
The new rules will be implemented at various times from 2017 and beyond, depending on the jurisdiction and circumstances of the counterparty. The first key deadline for most counterparties is expected to be 1 March 2017.
The reforms are complex and have wide ranging impacts for financial counterparties and systemically important non-financial counterparties.
The aim of these rules is to mitigate the risks that stem from OTC derivatives ― particularly in light of their somewhat detrimental role in the build-up to the global financial crisis of 2008.
Principal among these are:
- Funding implications - when a party is required to transfer VM, this will need to be funded. In the case of IM, the funding implications are greater. IM must be held in a segregated account with an independent custodian and cannot be re-used.
- Settlement timing - counterparties will need to consider their ability to comply with regulatory constraints around timing and frequency of margin exchange and where this is difficult, what solutions are available.
- Processes - counterparties will need to put in place operational and risk management processes necessary to comply with the new rules. For counterparties who do not currently margin, changes in risk management and operations will be significant.
Because IM is a new concept, it will take substantial effort to put in place ― and will likely involve developing capability to calculate and agree IM exposure using a risk based model, and establishing custodial arrangements to facilitate prompt settlement of segregated margin transfers. Dispute resolution mechanics will also need to be developed.
Read ANZ's overview of Uncleared OTC Derivatives: Margin Reforms and Their Implications for Counterparties.
Watch the ANZ webinar “Life on the margin” - Navigating the Non-Centrally Cleared Derivatives Margin Reforms.
Rohit Harjani, Rates Investor Sales, ANZ
Niamh Targett, Associate Director, Financial Institutions Group, ANZ
Robert Fievez, OTC Reform Project, ANZ
For any comments or feedback please contact the authors at GlobalFIGInsights@anz.com
PUBLISHED NOVEMBER 2016
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