With the release of a revised implementation timeline for margin requirements for uncleared derivatives (the “Basel framework”) in March, the Basel Committee on Banking Supervision (“BCBS”) and the International Organization of Securities Commissions (“IOSCO”) signaled that they have solidified the scope of uncleared swap margin regulations.
The Basel framework was devised following an extensive process of proposals and feedback. Despite that process, following the release of the framework in 2013, the organizations received a large volume of comments, thereby prompting the delay. As a result, the requirement for financial firms (as defined by national regulators) to collect and post initial margin will be delayed until September 2016. The requirement for those firms to exchange variation margin will also be delayed until September 2016, and will be subject to a six- month phase-in period.
The Basel framework margin requirements, designed with the dual purpose of reducing systemic risk and promoting central clearing, apply to all uncleared derivatives, with the exception of physically settled foreign exchange forwards and foreign exchange swaps. Additionally, the margin requirements will not apply to uncleared derivatives involving nonfinancial entities (as defined by national regulators), as such transactions are considered to pose little to no systemic risk and are generally exempted from most countries’ central clearing mandates.
Based on the original Basel framework, the Commodity Futures Trading Commission and the various banking prudential regulators (collectively, the “Regulators”) proposed that uncleared derivatives margin rules (the “Proposal”) primarily apply to swap dealers and indirectly to financial end users (such as investment funds) with material swaps exposure. Material swaps exposure is defined as an average daily aggregate notional amount of uncleared swaps, uncleared security-based swaps, foreign exchange forwards and foreign exchange swaps (“uncleared swaps products”) with all counterparties for the business days in June, July and August of the previous calendar year exceeding $3 billion.
Pursuant to the Proposal, swap dealers are required to collect initial margin for uncleared swaps with counterparties that are financial end users with material swaps exposure. The amount of initial margin will be equal to or greater than an amount determined through either a risk-based model (approved by the Regulators) or a standardized table method (set forth in the Proposal). In either case, market participants may see changes to the way their swap dealers’ counterparties calculate initial margin.
The Regulators proposed a phased-in compliance schedule for initial margin requirements, beginning Dec. 1, 2015, for swap dealers and counterparties that each have $4 trillion in average daily aggregate notional amount of uncleared swaps products for the period mentioned above. All market participants would eventually be covered by Dec. 1, 2019.
The Proposal also requires that swap dealers exchange variation margin with all financial end users (regardless of whether such end users have a material swap exposure), and allows swap dealers to net across trading agreements that meet certain minimum requirements. As a result, certain investment funds that are not currently receiving variation margin under their trading agreements may become entitled to receive such amounts. The rules with respect to variation margin are proposed to take effect Dec. 1, 2015.
Since BCBS and IOSCO have officially delayed the implementation of the Basel framework until September 2016, market participants will need to monitor how and when the Regulators will update and finalize their Proposal. The adoption of final rules will be noteworthy, as such rules have the potential to change the amount of initial margin and variation margin to be exchanged by investment funds and their dealer counterparties. In that respect, ISDA is currently developing a standard initial margin model intended for broad use by market participants under their credit support documentation. Legal documentation will also need to be amended to accommodate the new regulatory requirements.
