Further to last week’s detailed report by the Bank of International Settlements (BIS) on the cost of regulatory reforms on a macroeconomic level, The Basel Committee on Banking Supervision and the International Organization of Securities Commissions (IOSCO) have announced today the final framework for margin requirements for non-centrally cleared derivatives.
FX Forwards And Swaps Granted Exemption
The framework exempts physically settled foreign exchange (FX) forwards and swaps from initial margin requirements. Variation margin on these derivatives should be exchanged in accordance with standards developed after considering the Basel Committee supervisory guidance for managing settlement risk in FX transactions, which was finalized in February this year.
Instrumental to the standards set in February, banks and financial institutions must ensure that all FX settlement-related risks are effectively managed and that practices are consistent with those used for managing other counterparty exposures of similar size and duration.
Furthermore, institutions should reduce principal risk as much as practicable, by settling FX transactions through the use of financial market infrastructures (FMIs) that provide PVP arrangements. Where PVP settlement is not practicable, the bank should properly identify, measure, control and reduce the size and duration of its remaining principal risk.
In accordance with the correct analysis of capital needs, all FX settlement-related risks should be considered, including principal risk and replacement cost risk and that sufficient capital is held against these potential exposures, as appropriate, and banks must use netting arrangements and collateral arrangements to reduce replacement cost risk and should fully collateralize mark-to-market exposure on physically settling FX swaps and forwards with counterparties that are financial institutions and systemically important non-financial entities.
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Margin Requirements Final Ruling
The framework which was announced today also exempts from initial margin requirements the fixed, physically settled FX transactions that are associated with the exchange of principal of cross-currency swaps. However, the variation margin requirements that are described in the framework, apply to all components of cross-currency swaps.
It further asserts that one-time rehypothecation of initial margin collateral is permitted, subject to a number of strict conditions. This should help to mitigate the liquidity impact associated with the requirements.
A number of other features of the framework are also intended to manage the liquidity impact of the margin requirements on financial market participants. In particular, the requirements allow for the introduction of a universal initial margin threshold of €50 million, below which a firm would have the option of not collecting initial margin. The framework also allows for a broad array of eligible collateral to satisfy initial margin requirements, thus further reducing the liquidity impact.
Finally, the framework published today envisages a gradual phase-in period to provide market participants with sufficient time to adjust to the requirements. The requirement to collect and post initial margin on non-centrally cleared trades will be phased in over a four-year period, beginning in December 2015 with the largest, most active and most systemically important derivatives market participants.
Forex Magnates spoke to David Andrews, Founder and CEO of FX ECN Atom8 in London to ascertain his view on the proposals: “These proposals, like those mandating centralized clearing, have the perhaps unintended consequence of concentrating risk in the CCPs, their banks and the same banks holding collateral for the non-cleared OTC transactions” is Mr. Andrews’ opinion.
“The transitional provisions mitigate the implementation risks to a degree, but such proposals increase the costs to market participants and traditionally three consequences follow: the affected market shrinks or closes, it restructures somewhere/somehow out of scope or the end-user pays more. Whether this is positive or negative depends entirely on your perspective” he concluded.