European regulators have begun a second consultation on new rules requiring initial and variation margin to be exchanged for over-the-counter swap transactions not cleared through central counterparties.
The consultation on draft regulatory technical standards for a new swaps regime that is scheduled to hit participants next September is open for just one month as European regulators seek to align with the pace already set by US authorities.
A public hearing on the new framework proposed by the European Securities & Markets Association, the European Banking Authority and the European Insurance and Occupational Pensions Authority is scheduled for June 18, with the consultation set to conclude on July 10.
Proposals currently being considered by US regulators are at a more advanced stage. The CFTC released draft proposals last autumn and at the FIA’s IDX Derivatives Expo in London this week, CFTC chairman Timothy Massad confirmed that a final proposal on uncleared swaps margin remained a key priority for the agency over the coming months.
“This is one of the most important pieces of the framework for regulating the swaps market,” Massad told delegates.
“Margin for uncleared swaps is essential to mitigating the risk to our financial system and the broader economy that can come from uncleared bilateral swap transactions.”
The magnitude of changes required to systems and processes as counterparties adapt to the new regime has already resulted in a nine-month delay on implementation. The rules were initially set to go live at the end of this year, but some warn that even with an extension that includes a phased in approach, the current timetable remains ambitious.
“It’s important to note that industry participants can’t begin to prepare fully until final rules are published,” said ISDA CEO Scott O’Malia in a statement.
“We would ask national regulators in the US, Europe and Japan to work quickly and in coordination to finalise their rules as soon as possible in order to give market participants sufficient time to develop and implement the infrastructure, technology and documentation necessary to meet the requirements.”
Speaking at the London event, Massad noted the harmonised approach that global regulators have taken on the issue – something that has troubled other areas of derivatives regulation such as the recognition of overseas swap clearing regimes.
“We recognise the importance of having the uncleared margin rules of different jurisdictions be as consistent as possible. We do not want to create the potential for regulatory arbitrage or disruption in the market by creating unnecessary differences,” he told delegates.
“We have been working with European and Japanese regulators, who are also currently considering margin rules, to harmonise our rules as much as possible.”
He is hopeful similarities will be found on many of the key issues including overall thresholds, when margin must be collected, timing of implementation, and the basic standards for initial margin models.
ISDA is leading efforts to align the manner in which collateral is exchanged with its development of the Standard Initial Margin Model. Market participants believe it could save trillions of dollars in margining costs compared to table-based calculations offered by Basel regulators and reduce the potential for disputes between counterparties.
Closing the de-guarantee loophole
In consideration of the cross-border application of uncleared margin rules, Massad is seeking to address another regulatory bugbear by closing a loophole that has enabled US banks to avoid exposing offshore counterparties to US swap regulations.
By removing guarantees to their overseas affiliates, US banks have ensured that non-US counterparties can avoid the net of Dodd Frank by routing swaps to those non-guaranteed affiliates rather than the US entity.
So-called “de-guaranteeing” has also been motivated by a desire among some US parent entities to limit the impact of the new US margin requirements on uncleared over-the-counter swaps transactions, Massad noted in his comments this week.
The CFTC has reviewed the practices of several dealers on the issue and Massad is close to proposing new rules that recognise the fact that there can be a risk to a US entity from a foreign affiliate even if there is no explicit guarantee.
“If the financial results and position of the non-US swap dealer are consolidated in the financial statements of the US parent, then we should take that into account, whether or not there is an explicit guarantee,” Massad said.
The CFTC has considered three approaches to the cross border treatment uncleared margin rules, comprising a guidance approach, which is applied on a transaction basis with a broad exclusion for foreign trades; an entity approach that applies the margin rule to all uncleared swaps of a registered swap dealer without any exclusions; and a third approach that is entity based but also provides for substituted compliance in some cases.
Massad prefers a hybrid approach, which he views as more effective in clamping down on the “de-guarantee” loophole and is also the option most closely aligned with US bank regulator proposals.
“I believe the hybrid approach I am proposing is a good way to address this issue. The approach I would support would also provides for substituted compliance,” he said. “The limited exclusion available – which applies only if neither party is guaranteed or consolidated with a US person – helps address the concern that there is risk to the US even if there is no explicit guarantee.”
Complexity
However, some believe that the method could introduce additional complexity to the framework and represent a departure from the cross border treatment for cleared swap transactions. Swap dealers would need comply with US rules in all their transactions, but transactions with certain non-US counterparties would be entitled to substituted compliance that would see margin posted in accordance with foreign rules and margin collected in accordance to US rules.
Some market participants have expressed concern that the approach could prove cumbersome given the requirement for systems that comply with rules across separate regimes.
“We are still discussing this internally as well as with the bank regulators, so you will have to wait a bit longer for anything further,” said Massad. “I am suggesting that we propose such an approach and invite public comment on it.”
