Corporate end users dodged the swap clearing and margin requirements levied on financial firms that followed the 2008 financial crisis. However, they soon must abide by what may prove to be a tedious requirement for some companies if they want to continue trading over-the-counter (OTC) derivatives. That’s according to a Chatham Financial executive at The NeuGroup’s November Treasurers’ Group of Thirty (T30) meeting hosted by the Kennett Square, PA-based derivative advisory firm.
Under Basel Committee margin guidelines and the rules US and non-US regulators have subsequently put into place, OTC derivative market participants must determine the regulatory classification of their swap counterparties, whether margin requirements apply, and if so to what extent. That requirement applies both to market participants that must comply with margin requirements as well as nonfinancial corporates that are exempt from the regulatory margin rules, and to each entity within the corporation that trades derivatives.
For large multinational corporations (MNCs) with affiliates scattered around the globe that trade OTC derivatives under different regulatory regimes, that could end up being a fairly burdensome task.
To facilitate matters, the International Swaps and Derivatives Association (ISDA) published a self-disclosure letter (SDL) in June aimed at providing market participants with a standard form for providing counterparties with the information necessary “to determine if and when compliance with one or more of these new regulatory margin regimes will be required,” noted ISDA in the document’s preface. In conjunction with ISDA, Markit, the data and trade-processing firm, has published an electronic version of ISDA’s SDL, and certain banks are relying on their own bilateral agreements in lieu of the SDL.
In order to continue trading after March 1, 2017, an entity must disclose its regulatory classification to its counterparties. A dealer bank will refuse to trade with an entity that has failed to disclose its regulatory classification after that date because the dealer bank will not be able to determine whether the trade will be subject to the regulatory margin rules.
Should the Trump Administration and Republican congress repeal margin requirements by March 1—a highly unlikely event—US corporates trading with US counterparties would be relieved of their self-disclosure obligation in the US. However, a US corporate trading with a non-US counterparty and any affiliates trading outside the US will be required to complete the SDL.
ISDA’s SDL template comprises the self-disclosure questions require by margin rules specific to Canada, Japan, Australia, Switzerland, the European Union, and the US; Hong Kong and Singapore are expected to finalize their respective rules in the near future, soon after which their requirements will be included in the SDL template.
“Given the complexity of trading relationships and regime-specific regulations, these determinations could be quite difficult to make if left to the counterparties without a foundational framework to work with,” said Ankur Patel, director of corporate regulatory advisory at Chatham Financial.
The SDL primarily benefits bank counterparties, streamlining their information gathering process so they can efficiently determine the type of entities they’re dealing with.
Chatham emphasized in its presentation that all hedging entities must complete the SDL, which generally includes the following items:
- General biographical information
- Entity classifications/status in the US
- Entity classifications/status in the EU
- Other sections to be completed by jurisdiction, such as Canada, Japan and Switzerland, as requested by bank counterparties