BIS and IOSCO release final framework on margining for non-centrally cleared derivatives; exempt FX.
Non-financial users of FX swaps and forwards are likely cheering the latest OTC framework that excludes them from posting margin for trades.
On Monday the Bank for International Settlements (BIS) and International Organization of Securities Commissions (IOSCO) released the final framework for margin requirements for non-centrally cleared derivatives. This settles the question of requiring margin that G20 leaders originally agreed to in 2011.
Since it was determined that physically settled FX forwards and swaps would not have to be centrally cleared, there was a push by the G20 to have parties post margin before trading. “Margin requirements can further mitigate systemic risk in the derivatives markets,” the G20 said back then. “In addition, they can encourage standardisation and promote central clearing of derivatives by reflecting the generally higher risk of non-centrally-cleared derivatives.”
But the industry argued that having to post margin would increase costs. They contended consumers would be hit hardest. “End-users predominantly use derivatives to hedge or reduce risk,” wrote the US Coalition for Derivatives End-Users, an organization made up of companies and trade associations, in a letter to the BIS in March. “The use of derivatives to hedge commercial risks benefits the global economy by allowing a range of businesses—from manufacturing to health care to agriculture to technology—to improve their planning and forecasting and offer more stable prices to consumers and a more stable contribution to economic growth.”
As such, the BIS and IOSCO, taking into account “feedback from two rounds of consultations” and a quantitative impact study, decided to exempt FX derivatives inserting into their framework several modifications.
- “The framework exempts physically settled foreign exchange (FX) forwards and swaps from initial margin requirements,” the regulators said in a statement. “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.”
- The framework 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.
- “One-time” re-hypothecation 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.
In the final framework, the BIS and IOSCO also spread a little cheer to those entities that will be required to post margin, offering a gradual phase-in period “to provide market participants with sufficient time to adjust to the requirements.”