On 3 April 2020, the Basel Committee on Banking Supervision (BCBS) and the International Organization of Securities Commissions (IOSCO) announced that they had agreed to extend the deadline for completing the final two implementation phases of the margin requirements for non-centrally cleared derivatives by one year, from 1 September 2021 to 1 September 2022. Such extension, which follows a first one-year deferral that had been decided on July 2019, was awaited by the industry and is expected to provide additional operational capacity for firms to respond to the immediate impact of Covid-19 and at the same time, facilitate covered entities to act diligently to comply with the requirements by the revised deadline. Following this second extension, the three European supervisory authorities (ESAs) published on 23 November 2020 a third draft amendment to the European regulation on over the counter (OTC) derivatives, central counterparties and trade repositories (EMIR), following that of December 2019 and May 2020, which aimed at reflecting into European Union (EU) laws the BCBS and IOSCO announcement.
Margin requirements for non-centrally cleared derivatives
Counterparties to a non-centrally cleared OTC derivative contracts are subject to margin requirements in order to hedge their exposures and reduce the systemic impact of a counterparty default. In this respect, article 11 of EMIR requires financial and non-financial counterparties above certain clearing thresholds which enter into non-centrally cleared derivatives to have risk management procedures in place that provide for the timely, accurate and appropriately segregated exchange of collateral. This general principle is specified by the Commission Delegated Regulation (EU) 2016/2251 of 4 October 2016 (Margin Regulation), which exposes, inter alia, the methodologies to be used for calculating initial and variation margins and also sets the eligibility and diversification criteria that collateral should meet, it being noted that “initial margin” is the collateral collected by a counterparty to cover its current and potential future exposure in the interval between the last margin exchange and the liquidation of positions after the counterparty's default or the hedging of this exposure, and is intended to protect counterparties against future adverse movements in the value of their derivatives transactions.
In order to determine which of them are subject to initial margin requirements, entities should calculate the average notional amount of the non-centrally cleared OTC derivative transactions (calculated at group level) that were outstanding on the last business day of March, April and May of the precedent year (AANA). All instruments (including intra-group transactions, physically settled forward, foreign exchange contracts, currency swaps, etc.) are included in the calculation of this AANA, even if they would eventually benefit, as the case may be, from an exemption to the exchange of initial margins requirement.
Objectives of margin requirements for non-centrally cleared derivatives
Margin requirements for non-centrally cleared derivatives especially aims at reducing systemic risk. Indeed, although derivatives can only be centrally cleared if they are standardised enough, non-centrally cleared derivatives, totalling hundreds of trillions of dollars in notional amounts as per IOSCO, pose the same type of systemic contagion and spill over risks that materialised in the recent financial crisis. Thus, margin requirements for non-centrally cleared derivatives aim at limiting these risks of contagion and spill over effects in case of default of a derivatives counterparty by ensuring that sufficient collateral is available to offset losses as well as reducing the risks associated with potentially destabilising procyclicality and limiting the build-up of uncollateralised exposures.
Meanwhile, the effectiveness of margin requirements would likely depend on adequate harmonisation at international level, to the extent that a lack of global consistency could raise both regulatory arbitrage and unlevel playing field concerns (i.e. financial institutions that operate in the low-margin locations could gain a competitive advantage). For that reason, international regulators, including the EU’s, should align on the BCBS and IOSCO announcements.
Timeline for implementation of initial margin requirements
In accordance with the Margin Regulation, an entity (above clearing thresholds) should implement the initial margin requirements as from a certain date between 1 September 2017 and 1 September 2020, depending on the AANA calculated: indeed, the implementation of this obligation is subject to a five-phase timetable. Whereas the four first phases have already been implemented, the fifth and last one was supposed to enter into application on 1 September 2020.
However, in view of the sharp increase in the number of institutions affected by this deadline and in order to ensure a smooth and consistent implementation of this requirements, the BCBS and IOSCO published a revised regulatory framework in July 2019, providing that the threshold applicable in 2020 would be raised from EUR8 billion to EUR50 billion and that the EUR 8 billion threshold would be extended by one year to September 2021. Further, in the current context and with regard to the many challenges and difficulties posed by the spread of Covid-19 pandemic, notably as regards the displacement of staff and the need for firms to focus resources on managing the risks associated with current market volatility, the BCBS and IOSCO have agreed on a further one-year extension of the deadline for completing the implementation of the last two phases of the margin requirements for non-centrally cleared derivatives: with this new extension, the two final implementation phases will respectively take place on 1 September 2021, as regards covered entities with an AANA of non-centrally cleared derivatives greater than EUR 50 billion, and on 1 September 2022 as regards covered entities with an AANA of non-centrally cleared derivatives greater than EUR8 billion.
Whereas the Swiss Financial Market Supervisory Authority (FINMA), has already announced that it had implemented both these extensions into national laws, the ESAs published new regulatory technical standards (RTS) on 4 May 2020 (ESAs 2020 09), which version was replaced by a new one released on 23 November 2020, in order, inter alia, to amend article 36 of Commission Delegated Regulation (EU) 2016/2251 of 4 October 2016 supplementing EMIR with regard to regulatory technical standards for risk-mitigation techniques for OTC derivative contracts not cleared by a central counterparty (the Margin Regulation) by:
- adding an implementation phase, whereby as from 1September 2021, where both counterparties have (or belong to groups each of which has) an aggregate average notional amount (AANA) of non-centrally cleared derivatives above EUR50 billion, initial margin requirements should apply; and
- deferring the date of implementation of phase 5 (thereby becoming phase 6) from 1 September 2020 to 1 September 2022 where both counterparties have (or belong groups each of which has) an AANA of non-centrally cleared derivatives above EUR8 billion.
In addition, this RTS also extends the time window for the counterparties to novate certain contracts to a counterparty established in the EU without triggering the application of the bilateral margin procedures and the related margining requirements, from 21 December 2020 to 30 June 2022, in order to circumvent the disincentive to transfer contracts to firms established in the EU.
However, under EU laws, the draft RTS published by the ESAs has not been endorsed yet by the European Commission: as a consequence, article 36 of the Margin Regulation still provides that initial margin requirements will start applying as from 1 September 2020, where both counterparties have (or belong to groups each of which has) an AANA of non-centrally cleared derivatives above EUR8 billion. Therefore, the ESAs indicate that they expect competent authorities to apply the EU framework in a risk-based and proportionate manner until the amended Margin Regulation enter into force.
and then 