Final EU Margining RTS Published – Some Good, Some Bad.
Final Margining RTS published – some good, some bad.
On 8 March, the ESAs – ESMA, EBA and EIOPA – after a few delays, published the long awaited final draft Regulatory Technical Standards (“RTS”) which set out the margining requirements mandated under EMIR for non-centrally cleared OTC derivatives. The RTS has now been submitted to the European Commission for its endorsement and the Commission will have three months to endorse the RTS or to endorse with amendments. Although the RTS is therefore by no means definitive, the general expectation is that there will be no material changes to the document. Where considered necessary there may (and likely will be) some informal advocacy by ISDA to the European Commission with a view to implementing minor changes. The settlement timeline for posting variation margin (VM) and initial margin (IM) is one of the main concerns and the intense lobbying with the regulators prior to publication of the RTS for more time than the “T+1” does not appear to have paid off.
Below, I will set out some of the main points proposed under the RTS. Please note however, that the wording of the RTS is not always conclusive and has already proven to be open to different interpretation. During the next couple of weeks the market will try to get to grips with the RTS and it is expected to be further discussed in detail in the context of the ISDA WGMR initiative during that period with a view to determining whether any further advocacy needs to be undertaken.
Entities in scope and implementation time-line
There is no change in the RTS in terms of the entities in scope for the margin requirements for non-centrally cleared OTC derivatives: the rules will apply to financial counterparties and non-financial counterparties above the clearing threshold, even when one of the counterparties is established in a non-EU country but would have been subject to the RTS had it been established in the EU. Any non-centrally cleared OTC derivative trades by such counterparties will be subject to IM, provided that the aggregate average notional amount (“ANNA”) of non-centrally cleared derivatives of the group each counterparty belongs to, will be at least EUR 8 billion. If that amount is below that threshold there will not be any obligation by the counterparties to post and collect IM but there will however be an obligation to post and collect VM.
In terms of implementation of the margining requirements, the time-line has not changed. This means that the implementation of the IM requirements will be rolled out over the next four years, depending on the level of a counterparty’s AANA as calculated on certain dates during each of such years, whereas the VM requirements will apply from 1 March 2017 at the very latest. The RTS has now clarified in so many words that in calculating AANA only one leg of intra-group transactions will have to be counted to the threshold.
Foreign exchange contracts
The carve-out from IM for physically settled foreign exchange forwards, physically settled exchange swaps and with respect to principal in cross-currency swaps is in line with the US margin rules. The exchange of VM for these trades has been considered a sufficient cover of risk by the regulators. In the absence of a consistent definition in the EU for physically settled foreign exchange forwards however, the VM requirement for such trades has been postponed until the earlier of 31 December 2018 or the date of the Commission Delegated Act which will define this type of derivative under MiFID II.
Calculation and posting of VM and IM
Both VM and IM will have to be calculated on a daily basis and the RTS allow for one additional business day for the exchange of margin in cross-border netting sets over different time zones. The RTS seems to provide for a scenario where this could be T+2 for VM (Article 13.3 under (b) of the RTS) although the conditions for this extension to apply are not clear. The lack of flexibility in the RTS on this point is a disappointment, especially since there has been a fair amount of advocacy both in the EU and the US to ensure that the margining rules take challenging cross-border scenarios into account in determining settlement time-lines. It is expected that there will be further advocacy to the regulators and/or the European Commission on this point going forward.
Eligibility of collateral and concentration limits
The provisions on eligibility of collateral have not changed materially. However, unlike the draft RTS, the final RTS has now carved out VM from the concentration limits and has limited these to IM only.
Segregation of IM
IM collateral will have to be fully segregated with a third party holder or custodian or through some other legally binding arrangement, all with a view to being available to the posting counterparty in a timely manner in case of the collecting party’s default. It may not be re-hypothecated, re-pledged or re-used by the collecting counterparty. For cash IM this means depositing the cash with a third party holder or custodian not part of either counterparty’s group or with a central bank. The enforceability of such segregation arrangements will have to be covered in ‘independent legal reviews’ which the RTS now explains can be an in-house opinion or an external legal counsel opinion.
8% FX haircut
The RTS is now clear on what collateral will be subject to the currency mismatch haircut of an additional 8%:
- Cash VM: no FX haircut;
- Non-Cash VM: no FX haircut, unless posted in a different currency than those agreed with the counterparty in the underlying documentation;
- Cash IM and Non-Cash IM: no FX haircut, unless posted in a currency different from the Termination Currency in the underlying documentation.
Dealing with non-netting jurisdictions
The RTS contains specific rules for dealing with counterparties which are established in jurisdictions where the above mentioned ‘independent legal reviews’ fail to confirm the full enforceability of bilateral netting arrangements at all times or segregation arrangements in relation to IM. A counterparty may be exempted from posting (but not collecting) IM and VM from counterparties in such jurisdictions. Under some additional conditions a counterparty can even trade with counterparties in such non-netting jurisdictions without exchanging any VM or IM but such exposures should understandably limited to a fairly low level set out in the RTS.
The RTS provides for delayed implementation of some or all of its provisions for the following scenarios:
- posting of IM and VM for intra-group transactions where one of the two counterparties in the group is domiciled in a third-country for which no equivalence determination has yet been provided will be delayed with three years from the date of entry into force of the RTS;
- the requirement to exchange IM by counterparties for which this requirements kicks in by 1 September 2016 for intra-group transactions will be delayed until 1 March 2017 to allow these dealers to get their intra-group exemptions for those trades in place;
- IM and VM requirements for non-centrally cleared OTC derivatives on single-stock options and index options will be delayed with three years from the date of entry into force of the RTS.
What are you thoughts on the RTS? Let me know in the comments, Peter