10 March 2016

Margin calls nearly finalised for non-cleared derivatives under EMIR

What has happened?

On 8 March 2016, the European Supervisory Authorities jointly published the final draft regulatory technical standards on margin requirements under EMIR for over the counter (“OTC”) derivative contracts that are not centrally cleared through a central counterparty.

The rules are designed to reduce counterparty credit risk and mitigate potential systemic risk by requiring certain “qualifying counterparties” to post initial margin (“IM”) and variation margin (“VM”) in respect of their non-cleared OTC derivative positions when trading with each other.  Financial counterparties and NFC+s[1] will be classed as qualifying counterparties for these purposes, including when they trade with non-EU counterparties who would be treated as a qualifying counterparty if established in the EU.  The requirements will also apply to trades between two non-EU counterparties where the contract has a direct, substantial and foreseeable effect in the EU.

If adopted by the European Commission, the rules will apply from 1 September 2016, subject to certain threshold tests and phase-in periods.  For example, the requirements for IM will, at the outset, apply only to the largest counterparties.

The requirements

Where both parties to a trade are qualifying counterparties, they will be required to exchange IM and VM when they enter into non-centrally cleared OTC derivatives.

The VM requirement

  • The VM requirement will apply from 1 September 2016 where both qualifying counterparties (either at an entity or group level) each have an aggregate month-end average notional amount of non-centrally cleared OTC derivatives for March, April, May 2016 which exceeds Euro 3 trillion.  For all other qualifying counterparties, the variation margin rule will apply from 1 March 2017.

The IM requirements

  • The IM requirements are to be phased in as follows:
  • From 1 September 2016: where both qualifying counterparties (either at an entity level or group level) each have an aggregate month-end average notional amount of non-centrally cleared OTC derivatives for March, April, May 2016 which exceeds Euro 3 trillion;
  • From 1 September 2017: where both qualifying counterparties (either at an entity level or group level) each have an aggregate month-end average notional amount of non-centrally cleared OTC derivatives for March, April, May 2016 which exceeds Euro 2.25 trillion;
  • From 1 September 2018: where both qualifying counterparties (either at an entity level or group level) each have an aggregate month-end average notional amount of non-centrally cleared OTC derivatives for March, April, May 2016 which exceeds Euro 1.5 trillion;
  • From 1 September 2019: where both qualifying counterparties (either at an entity level or group level) each have an aggregate month-end average notional amount of non-centrally cleared OTC derivatives for March, April, May 2016 which exceeds Euro 0.75 trillion;
  • From 1 December 2020: where both qualifying counterparties (either at an entity level or group level) each have an aggregate month-end average notional amount of non-centrally cleared OTC derivatives for March, April, May 2016 which exceeds Euro 8 billion,
in each case, application is determined by aggregating all of the group’s non-centrally cleared OTC derivatives, including exposures arising either from OTC derivative contracts or in respect of counterparties that are permanently or temporarily exempted (in whole or in part) from margins.
  • In relation to IM, counterparties can agree not to exchange margin if the initial margin required to be exchanged is equal to or lower than Euro 50 million (unless they belong to the same group, in which case the threshold is Euro 10 million).  This margin calculation must be based on the margin exposure of the posting counterparty (or posting counterparty’s consolidated group) to the collecting counterparty (or collecting counterparty’s consolidated group).

Requirements relating to VM and IM

  • Qualifying counterparties can agree to a de minimis margin transfer amount, which should not exceed Euro 500,000 (i.e. if the total amount of IM and VM does not exceed Euro 500,000, both counterparties can agree not to exchange margin).
  • Eligible collateral for these purposes will include cash, high quality government bonds, corporate bonds, shares in major stock indices, gold and eligible shares or units in UCITS.
  • Very limited re-hypothecation and re-use of IM will be permitted (re-use is permitted in relation to cash collateral, but subject to the requirement that it must be reinvested to protect the liability that the counterparty collecting the collateral has towards the posting party).

Exemptions

  • In relation to intragroup OTC derivative transactions, which are exempt from the margin requirements if certain requirements regarding risk-management procedures are met and there are no practical or legal impediments to the transferability of own funds and the repayment of liabilities, the rules specify which requirements must be met and when such impediments should be deemed to exist.  The rules also establish uniform procedures for the granting of intragroup exemptions by national regulators.
  • The rules provide that qualifying counterparties can agree not to collect IM on physically settled foreign exchange forwards and swaps, or the principal in cross-currency swaps.  However, qualifying counterparties must exchange VM in relation to these contracts.  As there is not currently an agreed definition of physically settled foreign exchange forwards at EU level, the requirement to exchange VM in relation to physically settled foreign exchange forwards will not apply until the earlier of 31 December 2018 or the entry into force of the forthcoming legislation which will define physically settled foreign exchange forwards.

Next steps

The rules have been submitted to the European Commission, which has up to three months to decide whether to endorse the rules submitted.  The Commission may adopt the rules as they are, or choose to amend them.

[1] Non-financial counterparties whose rolling average position over a 30 working day period in OTC derivatives (net of their commercial and treasury financing hedges) exceeds a relevant clearing threshold.

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