The Basel Committee on Banking Supervision and the International Organization of Securities Commissions (“IOSCO”) released the final framework for margin requirements for non-centrally cleared derivatives. Under these global standards, all financial firms and systemically important non-financial entities that engage in non-centrally cleared derivatives will have to exchange initial and variation margin commensurate with the counterparty risks arising from such transactions.
Below are key principles set out in the framework.
- Appropriate margining practices should be in place with respect to all derivatives transactions that are not cleared by CCPs.
- 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.
- The methodologies for calculating initial and variation margin that serve as the baseline for margin 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 in question and (ii) ensure that all counterparty risk exposures are fully covered with a high degree of confidence.
- 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.
- 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 counterparty’s default; and (ii) the collected margin must be subject to arrangements that fully protect the posting party to the extent possible under applicable law in the event that the collecting party enters bankruptcy.
- Transactions between a firm and its affiliates should be subject to appropriate regulation in a manner consistent with each jurisdiction’s legal and regulatory framework.
- Regulatory regimes should interact so as to result in sufficiently consistent and non-duplicative regulatory margin requirements for non-centrally cleared derivatives across jurisdictions.
- 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.
Compared with the near-final framework proposed earlier this year, the final framework includes the following modifications:
- Exempts physically settled foreign exchange (“FX”) forwards and swaps from initial margin requirements;
- Exempts the fixed, physically settled FX transactions that are associated with the exchange of principal of cross-currency swaps from initial margin requirements; and
- Permits limited rehypothecation of initial margin collateral, subject to a number of conditions.
See: Margin Requirements for Non-Centrally Cleared Derivatives Framework; Press Release.
See also: Basel Committee and IOSCO Issue Near-Final Proposal on Margin Requirements for Non-Centrally Cleared Derivatives (February 20, 2013).