In an unexpected move, international financial regulators reissued a consultative paper seeking comment on revised margin requirements for over-the-counter swaps that further impacts the largest swap users. The revised proposal also highlights the differences between the US and international regulators’ swap-margin proposals that ultimately could limit corporates’ swap-counterparty choices.
The good news for nonfinancial corporate end users of swaps outside the US is that the consultative paper—put together by the working group comprising members of the Basel Committee on Banking Supervision and the International Organization of Securities Commissions (IOSCO)—continues to exempt them from initial and variation margin requirements. The reissued proposal, which was expected to be finalized by year-end, does not exempt financial firms and, depending on how the guidelines are interpreted by each country, may not exempt nonfinancial corporates that have finance units, such as auto companies’ lending divisions.
The consultative document introduces a new measure impacting un-exempted corporates, according to Ryan McKee, senior advisor at Chatham Financial, since it requires “universal two-way initial and variation margin for financial entities, meaning both parties to the trade will have to post margin.”
Currently, both initial and variation margin requirements are negotiated between counterparties. Ms. McKee said variation margin tends to be applied more often than initial margin, but in many circumstances counterparties do not currently exchange variation margin, so for them this would represent a new requirement.
US regulators’ swap-margin proposal, instead, would require nonfinancial corporate end users to post initial margin when the notional amount of their derivatives exceed a threshold to be determined by each bank counterparty.
“So the US has said that for nonfinancial counterparties, there will be a threshold above which margin will have to be posted. Whereas at the global level, regulators are saying no collateral required under any circumstances,” Ms. McKee said.
Since US regulators have interpreted Dodd-Frank as requiring them to impose margin on all OTC swap counterparties, the only way for nonfinancial end users to be exempted from those requirements is through a legislative fix. Tom Deas, treasurer of FMC Corp. and chairman of the National Association of Corporate Treasurers, noted that a bill to do just that passed the House of Representatives with significant bipartisan support last year, although it stalled in the Senate. The bill has been introduced again in both the House and Senate this year.
The complications arising from the US and international regulatory regimes’ different treatment of margin for nonfinancial corporates may be compounded if a proposal by Commodity Futures Trading Commission (CFTC) regarding regulatory jurisdiction comes to fruition as is.
The working group’s consultative paper proposes a corporate or financial entity follows the rules of its own jurisdiction, assuming regulators have deemed regulatory regimes are equivalent. The CFTC’s proposal, instead, would require any counterparty to a US corporate or financial institution to follow US rules. So a German corporate would have to post margin for a swap with a US bank if the corporate’s derivative position exceeds the bank’s threshold, even though it may not be required to do so under Europe’s rules.
“If you’re a corporate in Europe, and you know that by transacting with a US entity you will have less favorable margin treatment than if you transacted with an entity in Europe, you’re probably going to transact with the European entity,” Ms. McKee said.
Unlike the issue of swap margins requiring a legislative fix, the CFTC could choose the consultative paper’s more traditional approach to regulatory jurisdiction.
Comments are due March 15 on the consultative paper, which is anticipated to influence US regulators who have supported the goal of regulatory harmonization. Ms. McKee added that procedural requirements make it unlikely the guidelines will be adopted internationally before year-end.