The Basel Committee on Banking Supervision (BCBS) and the International Organization of Securities Commissions (IOSCO) have published a second consultative paper which represents a near-final proposal on margin requirements for non-centrally cleared derivatives.
This consultative document reflects the near-final policy framework after careful consideration of the responses to the first consultative document issued in July 2012.
BCBS and IOSCO formed the Working Group on Margining Requirements (WGMR) in October 2011 to develop a proposal on margin requirements for non-centrally cleared derivatives for consultation by mid-2012. In July 2012, an initial proposal was released for consultation. The initial proposal was followed by an invitation to comment on the proposal by Sept. 28 2012.
The proposed requirements would allow for the introduction of a universal initial margin threshold of 50 million. The results of a quantitative impact study (QIS) conducted in 2012 indicate that application of the threshold could reduce the total liquidity costs by 56% relative to a margining framework with a zero initial margin threshold, which was initially proposed in the July 2012 consultative paper on margin requirements for non-centrally cleared derivatives.
BCBSs and IOSCOs near-final policy for margin requirements for non-centrally cleared derivatives, as articulated through key principles addressing eight main elements, are as follows:
1. Appropriate margining practices should be in place with respect to all derivative transactions that are not cleared by CCPs. Except physically-settled FX forwards and swaps, the margin requirements apply to all non-centrally cleared derivatives. In relation to physically-settled FX forwards and swaps, the BCBS and IOSCO seek comment on the margin requirements for these instruments.
2. All financial firms and systemically-important non-financial entities (covered entities) that engage in non-centrally cleared derivatives must exchange initial and variation margin as appropriate to the counterparty risks posed by such transactions. All covered entities must exchange, on a bilateral basis, initial margin with a threshold not to exceed 50 million. The threshold is applied at the level of the consolidated group to which the threshold is being extended and is based on all non-centrally cleared derivatives between the two consolidated groups. Covered entities include all financial firms and systemically important non-financial firms. Central banks, sovereigns, multilateral development banks, the Bank for International Settlements (BIS), and non-systemic, non-financial firms are not covered entities.
3. The methodologies for calculating initial and variation margin that must serve as the baseline for margin that is collected from a counterparty should (i) be consistent across entities covered by the requirements and reflect the potential future exposure (initial margin) and current exposure (variation margin) associated with the portfolio of non-centrally cleared derivatives at issue and (ii) ensure that all counterparty risk exposures are covered fully with a high degree of confidence.
4. To ensure that assets collected as collateral for initial and variation margin purposes can be liquidated in a reasonable amount of time to generate proceeds that could sufficiently protect collecting entities covered by the requirements from losses on non-centrally cleared derivatives in the event of a counterparty default, these assets should be highly liquid and should, after accounting for an appropriate haircut, be able to hold their value in a time of financial stress.
National supervisors should develop their own list of eligible collateral assets based on the key principle, taking into account the conditions of their own markets. As a guide, examples of the types of eligible collateral that satisfy the key principle would generally include: cash; high-quality government and central bank securities; high-quality corporate bonds; high-quality covered bonds; equities included in major stock indices; and gold.
5. Initial margin should be exchanged by both parties, without netting of amounts collected by each party (i.e. on a gross basis), and held in such a way as to ensure that (i) the margin collected is immediately available to the collecting party in the event of the counterpartys default; and (ii) the collected margin must be subject to arrangements that fully protect the posting party in the event that the collecting party enters bankruptcy to the extent possible under applicable law. Initial margin should be exchanged on a gross basis and held in a manner consistent with the key principle above. Cash and non-cash collateral collected as initial margin should not be re-hypothecated, re-pledged or re-used.
6. Transactions between a firm and its affiliates should be subject to appropriate regulation in a manner consistent with each jurisdictions legal and regulatory framework. Local supervisors should review their own legal frameworks and market conditions and put in place initial and variation margin requirements as appropriate.
7. Regulatory regimes should interact so as to result in sufficiently consistent and non-duplicative regulatory margin requirements for non-centrally cleared derivatives across jurisdictions. Home-country supervisors should permit a covered entity to comply with the margin requirements of a host-country margin regime with respect to its derivative activities, so long as the home-country supervisor considers the host-country margin regime to be consistent with the margin requirements described in the paper.
8. Margin requirements should be phased-in over an appropriate period of time to ensure that the transition costs associated with the new framework can be appropriately managed. Regulators should undertake a coordinated review of the margin standards once the requirements are in place and functioning to assess the overall efficacy of the standards and to ensure harmonization across national jurisdictions as well as across related regulatory initiatives. The requirement to exchange variation margin will become effective on Jan. 1 2015.
Each covered entity engaging in non-centrally cleared derivative activity will compute the level of the entire notional amount of non-centrally cleared derivatives in which they are engaged as of month-end of the last three months of each year beginning in 2014. In 2015, any covered entity belonging to a group whose aggregate month-end average notional amount of non-centrally-cleared-derivatives for the last three months of 2014 exceeds 3.0 trillion will be subject to the requirements when transacting with another covered entity (so long as it also meets that condition). In 2016, any covered entity belonging to a group whose aggregate month-end average notional amount of non-centrally-cleared-derivatives for the last three months of 2015 exceeds 2.25 trillion will be subject to the requirements when transacting with another covered entity (so long as it also meets that condition).
In 2017, any covered entity belonging to a group whose aggregate month-end average notional amount of non-centrally-cleared-derivatives for the last three months of 2016 exceeds 1.5 trillion will be subject to the requirements when transacting with another covered entity. In 2018, any covered entity belonging to a group whose aggregate month-end average notional amount of non-centrally-cleared-derivatives for the last three months of 2017 exceeds 0.75 trillion will be subject to the requirements when transacting with another covered entity. On a permanent basis (ie in 2019 and beyond), any covered entity belonging to a group whose aggregate month-end average notional amount of non-centrally-cleared-derivatives for the last three months of the preceding year is less than 8 billion will not be subject to the initial margin requirements described in this paper.
Initial margin requirements will apply to all new contracts entered into after each of the dates described above. Applying the initial margin requirements to existing derivative contracts is not required.
The BCBS and IOSCO welcome comments from the public on the questions set out in this second consultative document by March 15 2013.
The paper is available on the websites of the Bank for International Settlements and IOSCO.
(JDC)