Last month, my blog, Blowing the derivative doors off, set the scene for the forthcoming regulation around non-cleared derivatives margining, known as BCBS 261.[1] Since then the Canadian and Japanese regulators have published their final rules and other countries, such as India, are expected to publish a consultative paper on the topic shortly. In Europe, the rules are close to being finalized as on March 8th the European Supervisory Authorities published the final draft regulatory technical standards. Barring any setbacks to the official adoption of the rules in the next couple of months, we’ve been taking a look at the actions financial services firms should prioritize to meet the new regulation.[2]
Being faced with such detailed changes can be a daunting task, especially when resources are stretched in meeting the complex rules in the first place and Wave 1 firms have less than 6 months to comply. With the release of this final draft, further efforts are required to “get down with the detail” and carry out an impact analysis of the new changes. Your firm needs to ask itself how the updated standards affect its already tight implementation plans. Are you aware of which changes are required for your internal IT build and processes? Do you have the resources in place to deliver the regulatory outcomes in a timely way?
Regulation priorities
Here are just some of the highlights from the final draft regulatory technical standards:
- Transitional provisions: For Physically Settled FX Forwards, the obligation to exchange initial margin (IM) and variation margin (VM) has been delayed to the earlier of December 31, 2018 or the publication of the Mifid II technical definition. In addition, exchange of IM and VM for single-stock equity options and index options, has been pushed back by three years. The current uncertainty of the publication date of the Mifid II Technical Definitions means firms are left with a tough choice: whether to include Physically Settled FX Forwards in their legal agreements and system implementations now (and be over-compliant) or leave them out, and risk a short notice period to be ready once the technical definitions are published.
- Intragroup: The ESAs have introduced a EUR 10 million threshold before IM needs to be exchanged for intragroup transactions. In addition, IM requirements for intragroup transactions will now only take effect on March 1, 2017, but if the exemption application is accepted, IM and VM will be deferred for three years or until an equivalence decision has been adopted pursuant to EMIR for the relevant third party. While the addition of the EUR 10 million threshold, and the clarification of exemptions allowed for intragroup transactions, is a positive sign, this forces firms to ensure that they can get the exemption approval on time to benefit from the relief. This is no mean feat, as firms are required to ensure that their entities meet a number of strict (and often subject to interpretation) criteria, before they can be granted exemption.
- Custody: Cash IM can now not only be deposited with a third-party custodian, but also with a central bank. The rules state that the choice of a firm’s custodian should take into account the custodian’s credit quality. Furthermore in relationships between OSIIs and GSIIs[3], a maximum of 20 percent of the total collateral collected from a single counterparty can be maintained in cash per single custodian. It is debatable whether the wording of the regulatory technical standards means only European Union (EU) regulated custodians are allowed to hold cash. Netting agreements must follow EU rules if at least one of the counterparties in the relationship is domiciled in the EU. With many Wave 1 firms looking to use one custodian for all their IM segregation requirements, the 20 percent threshold may prove to be a challenge. It may also be advisable for OSII and GSII firms to look at alternative options such as utilizing more non-cash collateral for IM, or using multiple custodians for transactions between each other.
- Concentration limits: Concentration limits now only apply to IM, and not VM. A EUR 10 million threshold is being introduced in addition to percentage restrictions. The new threshold, on one hand, enables firms to bypass some concentration limit requirements for relationships where the margin exchange amount is low, but, on the other hand, requires firms to monitor their total margin exchange, of certain types of collateral, across both IM and VM, with a counterparty daily. This can be more difficult if there is more than one Credit Support Annex (CSA) in use for the relationship pair.
- Margin calculation/collection date: Additional criteria for IM have been introduced to clarify that when parties are in the same time zone, the calculation shall refer to the netting set of the previous business day while; when parties are not in the same time zone, the calculation must refer to the netting set entered into before 4:00 p.m. in the first time zone where it is 4:00 p.m. Although the ESAs have extended the timeline for collecting IM from T+1 to T+2 when counterparties are trading across borders.
- Non-netting jurisdictions: The final draft rules now state that there is no requirement to post IM or VM to non-EU counterparties domiciled in a jurisdiction where netting arrangements are not enforceable. Furthermore an EU firm does not need to collect IM or VM if the aggregate notional of trades with such non-EU counterparties is less than 2.5 percent of the gross notional of its trades (excluding intra-group ones). While this is welcome news, the 2.5 percent cap might present a challenge for Wave 1 firms which have a large exposure to emerging markets.
Accenture is working closely with various Wave 1 financial services firms to help them navigate the above priorities and other complexities in readiness for the September 1, 2016 deadline. We are also helping firms who are faced with the March 2017 deadline and beyond—collaborating with their business, IT, legal and compliance teams to not only meet the regulation deadlines, but also support and advise on the implications of the rules for their strategic collateral operating models and technology architectures.
Find out more by contacting me, Rajesh Sadhwani, today.
[1] Also known as BCBS/IOSCO, Basel Committee on Banking Supervision, http://www.bis.org/publ/bcbs261.pdf
[2] The process involves the Commission, Council of Ministers and European Parliament all approving the legislation which can take a few months.
[3] Other Systemically Important Institution (OSII) and Global Systemically Important Institution (GSII)