07 December 2016

What a (marginal) relief, margin dates announced!

This article was written by Scott Farrell, Max Allan, Roslyn Hinchliffe, Claire Warren and Heidi Machin.

The Australian Prudential Regulation Authority (APRA) has announced the implementation timetable for derivatives margin and risk mitigation requirements for participants in Australian risk management markets.

The implementation dates and phase-in timetable now give market participants a deadline for compliance. For variation margin (VM), the requirements start on 1 March 2017. That deadline is getting perilously close. Fortunately, there is a 6 month transition period (until 1 September 2017). However, to benefit from the relief, APRA expects APRA covered entities to comply with the margin requirements on a best endeavours basis and on-board counterparties in a risk-focused manner. The requirements still apply to new qualifying transactions entered into from 1 March 2017.

For both prudential regulated entities and financial institutions (which is a broad category), now is the time to engage with determining whether margining requirements will apply and how to comply with them. In this Alert, we summarise the implementation timetable and the updated final version of requirements published by APRA yesterday.

The final Prudential Standard CPS 226 Margining and risk mitigation for non-centrally cleared derivatives (CPS 226), which imposes margin and risk mitigation requirements, complete with implementation timetables (and no square brackets!), has been published. The final prudential standard, and the letter to industry, can be found here.

A summary of the direct and indirect application to market participants of the October 2016 version of the margining and risk mitigation requirements, can be found here. The finalisation of the Australian margin requirements follows the legislative reforms introduced to facilitate Australian entities complying with the Australian and other global derivatives margin requirements. Our alerts which describe some of the reforms and the new laws themselves can be found here and here.

Can I ignore this?

If you enter into uncleared derivatives, no.

If you have any uncleared derivatives, a wave of margining disclosure documents and new credit support annexes may be already buffeting you. If not, you should expect to be awash with them soon. Now that the dates and reference periods are set, participants can start preparing documents in earnest.

Even if you are not prudentially regulated, you could be required to complete self-disclosure documents and enter into new credit support documents if you trade with a bank or other prudentially regulated entity which is caught by the Australian margin rules, or any other financial institution which is caught by any foreign margin rules.

I don’t currently collateralise my derivatives, can I ignore this?

No. Not necessarily. If your bank counterparty is subject to margin requirements itself when it trades with you, it will need to exchange margin with you in order to continue to trade with you once the new requirements commence.

So when does it all start?

Variation margin requirements commence on 1 March 2017 and apply to all new qualifying transactions entered from this date, subject to a transition period. APRA has announced a six-month transition period for APRA covered entities which are subject to the variation margin requirements. During the transition period, APRA expects APRA covered entities to comply with the margin requirements on a “best endeavours basis and on-board counterparties in a risk-focused manner”. The APRA covered entities must be in full compliance with the requirements by 1 September 2017.

Whilst this 6 month transition period will provide some extra time for entities to finalise implementation and reach full compliance for trades executed from 1 March 2017, the relief is not absolute. An APRA covered entity will be taken to comply with the variation margin requirements for the period between 1 March 2017 to 31 August 2017 if it uses its best endeavours to exchange variation margin with the covered counterparty during that period. It is unlikely to be enough just to wait another 6 months until September starts to get close.

The implementation timetable for variation margin requirements from the prudential standard looks like this:

Implementation Timetable for Variation Margin Requirements

The requirements to post and collect initial margin will be subject to a phase-in timetable that is broadly equivalent to the international timetable. The implementation timetable for initial margin requirements from the prudential standard looks like this:

Implementation Timetable for Initial Margin Requirements

The risk mitigation requirements in CPS 226 will take effect from 1 March 2018. This is a significant change from the previously anticipated start date.

Of course, there is a bit more detail in the prudential standard.

Did anything else change in the final rules?

As well as finalising the implementation timetable, APRA made a few changes to the Australian margin requirements. For example, in relation to the margining group definition, an APRA covered entity may elect to apply equivalent foreign accounting standards that apply to the consolidated financial statements of the APRA covered entity or covered counterparty, as relevant.

What hasn’t changed?

There are still a few parts of the prudential standard that have caused concern for market participants which were not changed in this final standard. These include that:

  • an arrangement that is a forward, swap or option, or any combination of those things, in relation to one or more commodities still needs to be margined. This is causing concern for participants in physical markets which may not be used to collateralising trades.
  • the concept of “financial institution” in the prudential standard is broad and the definition is inclusive rather than exhaustive. This is causing some difficulties for both sell-side and buy-side firms trying to identify their counterparties, and themselves, for the purposes of Australian, and international, margin requirements.
  • there is some concern as to whether the members of a Level 2 group which is headed by a foreign ADI can rely on the same automatic deference regime as that foreign ADI.

Hopefully some guidance on these issues is published in due course.

What do I do now?

The path is clear and the effort now required is more than marginal (this might be our last chance for a margin pun). It is a relief to get the final rules and the final timeframes, but there is a lot of real work to get ready for margining.

There is plenty to do. And it needs to be done very soon.

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