Financial Market Regulation BCBS / IOSCO Initial Margin Regulations

BCBS / IOSCO Initial Margin Regulations

Last update: 7 December 2018

In response to the financial crisis, the G-20 mandated the Basel Committee on Banking Supervision (BCBS) and Board of International Organization of Securities Commissions (IOSCO) to develop consistent global standards for non-centrally cleared over-the-counter (OTC) derivatives. In September 2013 BCBS-IOSCO published a global policy framework and timetable for OTC derivative margin reform which aimed to reduce systemic risk by ensuring collateral is available to offset losses caused by the default of a derivatives counterparty.

A key element to this is the requirement that financial firms and systemically important non-financial entities exchange both Variation Margin (VM) and Initial Margin (IM) to mitigate counterparty credit risk from uncleared OTC transactions. VM ensures that the current value of a derivative is collateralised and was already a standard feature of the OTC market. IM was traditionally less common but is designed to ensure there is a margin "buffer" to protect against potential losses following a change in value of a derivative position occurring between a counterparty closing out a position upon default of its counterparty and the last exchange of Variation Margin. 

Since the release of the final policy framework these global standards have been leveraged by various jurisdictional regulators across the globe to develop their own local rules. Margin rules have been finalised and are being enforced by the following regulators:

European Supervisory Authorities (ESA)
US Prudential Regulators (US PR)
US Commodity and Futures Trading Commission (CFTC)
Japan Financial Services Agency (JFSA)
Swiss Financial Market Supervisory Authority (FINMA)
Monetary Authority of Singapore (MAS)
Canadian Office of the Superintendent of Financial Institutions (OSFI)
Australian Prudential Regulation Authority (APRA)
South Korean Financial Supervisory Service (KFSS)
Hong Kong Monetary Authority (HKMA)

Implementation Timeline

IM and VM thresholds are being phased in at different times and are specific to each regulatory jurisdiction. Whether and when a particular counterparty is under a regulatory obligation to exchange IM will depend on:

  1. Whether it is the type of entity which is subject to IM requirements under a particular regime (an Obligated Entity(1));
  2. The volume of its Group's(1) non-cleared Over-The-Counter (OTC) derivatives business, commonly referred to as the Aggregate Average Notional Amount (AANA); and
  3. Who it is trading with

Each regulator has different rules for determining who is an Obligated Entity and has defined its own compliance dates and AANA threshold values, along with a methodology for calculating the AANA. It is expected that most regulators' compliance dates will broadly provide for the following phase-ins (note: threshold values below are taken from the EU regulations and will differ in each final jurisdictional rule-set; in addition, the currencies differ by rule set).

2016
Sep 1

2017
Feb 4

2017
Mar 1

2017
Sep 1

2018
Sep 1

2019
Sep 1

2020
Sep 1

  
   
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Covered Entities with AANA > €3trn(2) Covered Entities with AANA > €3trn(2) Covered Entities with AANA > €3trn(2) Covered Entities with AANA > €2.25trn(2) Covered Entities with AANA > €1.5trn(2) Covered Entities with AANA > €0.75trn(2) Covered Entities with AANA > €8bn(2)

(1) Please see full definitions in the ‘What you need to consider’ section
(2) When transacting with another Covered Entity exceeding the AANA Threshold

What is an "Obligated Entity” and what is a "Group”?

Whether a counterparty is an Obligated Entity and therefore potentially subject to the requirement to exchange IM varies by jurisdiction:

ESA
EU Financial Counterparties (FC) or Non-Financial Counterparties above the Clearing Threshold (NFC+) are obligated when transacting with other FC / NFC+, or Third Country (non-EU) Entities which would be FC / NFC+ if in EU. EU branches of TCE FC-equivalent entities are also obligated in certain circumstances.
US PR
Covered Swap Entities (Swap Dealer or Security Based Swap Dealer, Major Swap Participant or Major SBS Participants regulated by PR), transacting with other Swap Entities or Financial End Users(1) (bank or other specified regulated financial entity or an investment company, securitization vehicle, or other specified investment pool).
US CFTC
Covered Swap Entities (swap dealer or major swap participant not regulated by PR), are obligated when transacting with other Swap Entities or Financial End Users(1) (bank or other specified regulated financial entity or an investment company, securitization vehicle, or other specified investment pool).
JFSA
Covered entities in-scope when transacting with each other or with a non-Japan entity that is trading OTC derivatives “in the course of business” above a de minimis threshold.
Includes: Type 1 Financial Instruments & Business Operators (FIBOs), Banks that are Registered Financial Institutions (RFIs), Insurance Companies that are RFIs and Trust Accounts that are FIBOS/ RFIs and certain banks (The Shoko Chukin Bank Ltd; Development Bank of Japan Inc.; Shinkin Central Bank; and The Norinchukin Bank), each above a de minimis threshold.
FINMA
All Financial Counterparties (FC) and Non-Financial Counterparties (NFC) obligated when transacting with each other, except when a smaller non-financial counterparty (derivative positions below certain thresholds) is involved.
MAS
Covered Entities are in scope when transacting with each other or a Foreign Covered Entity (provided that trades are booked in Singapore). “Covered Entities” are licensed banks and merchant banks approved as financial institutions.
HK MA
Margin requirements apply to Authorised Institutions (AIs) that enter into in-scope derivatives with “Covered Entities” incorporated in or outside HK. Covered Entities include AIs, Licensed Corporations, other regulated financial institutions and others (regulatory text should be consulted for comprehensive definitions).
OSFI
Federally-Regulated Financial Institutions (FRFIs) are obligated when transacting with each other and with Financial Entities. Financial Entities include (but are not limited to) deposit-taking institutions, insurance companies, pension funds, hedge funds and asset managers. These must belong to a consolidated Group whose AANA in 2016 or any year thereafter exceeds CAD 12bn.
APRA
APRA Covered Entities are in-scope when transacting with each other and with Covered Counterparties. “APRA Covered Entities” include: Authorised Deposit-Taking Institutions (ADIs), including foreign ADIs; authorised banking Non-Operating Holding Companies (NOHCs) and authorised insurance NOHCs; Life Companies and registered life NOHCs; and Registrable Superannuation Entities (RSEs) under the SIS Act. “Covered Counterparties” are generally entities that are financial institutions or a systemically important non-financial institutions.
KFSS
Financial Companies licensed to conduct finance business by the KFSS are obligated when transacting with other Financial Companies. A "Financial Company" includes banks, broker/dealers, insurance companies, mutual savings banks, and others. The regulatory text should be consulted for a definitive list.

1) Note that a Financial End User (FEU) is only subject to the US rules when its counterparty is a Covered Swap Entity, and not subject if trading with another FEU

The "Group" definition varies by jurisdiction. Broadly speaking it is the Ultimate Parent of the Covered Entity together with such parent’s subsidiaries (i.e. all entities consolidated in the same set of financial statements), however there are specific jurisdictional definitions and nuances that must be observed, particularly with regards to specific entity types, for example funds. You should consult the specific regulatory text for further details.

When is Credit Suisse an 'Obligated Entity'?

The below table highlights under which regimes Credit Suisse entities can be considered Obligated Entities and directly required to exchange IM when facing an in-scope counterparty.

  ESA
US PR
US CFTC
JFSA
FINMA
MAS
HK MA
OSFI
APRA
KFSS
CREDIT SUISSE
INTERNATIONAL1
               
CREDIT SUISSE
SECURITIES (EUROPE)
LTD1
               
CREDIT SUISSE AG2       3
CREDIT SUISSE
CAPITAL LLC
                 
CREDIT SUISSE
SECURITIES (USA) LLC3
                   

1.Credit Suisse International and Credit Suisse Securities (Europe) Ltd’s US rule obligations only apply when facing a counterparty that brings a US nexus into the relationship. We consider a US nexus to be either (i) incorporated within the US; (ii) one or more “offices” located in the US specified on the ISDA Master Agreement between us; (iii) a Foreign Consolidated Subsidiary of a US-organised parent; and (iv) our counterparty’s trades benefit from a guarantee from a US entity. It should also be noted that US CFTC rules include a “principal place of business” test that may trigger a US nexus, but this test does not apply to the US PR rules.

2.Credit Suisse AG's branches apply substituted compliance for European rules in order to discharge its regulatory obligations under FINMA, MAS, HK MA, OSFI and APRA regimes. Credit Suisse AG Tokyo Branch is a registered RFI but is not yet a “Covered Entity” as it does not meet the de minimis branch trading threshold. However, should it meet that threshold in the future, Tokyo Branch will be considered a “Covered Entity” and will be obliged to exchange IM in accordance with the JFSA margin rules.

3.Credit Suisse AG’s Seoul branch is expected to become obligated to exchange IM with on-shore Covered Counterparties from September 2020.

4.Credit Suisse Securities (USA) LLC is not directly obligated to exchange IM under any of the published rules. However, note that it is considered a ‘Covered Counterparty’ under all regimes and will therefore be required to comply in order to facilitate a counterparty’s discharging of their own regulatory obligations.

What transactions are in scope for IM

Generally, all non-centrally cleared OTC derivatives are subject to the exchange of IM between in-scope parties, with the exception of FX spot, deliverable FX forwards and deliverable FX swap transactions, which are universally exempt from IM across all jurisdictional rule-sets.
There are also further differentiations and exclusions between the various regulations, as summarised in the table below.

ESA
  • IM requirements for single-stock equity options and index options are deferred until February 2020.
  • Physically settled commodity forwards are generally exempt from IM exchange, with certain exceptions should specific conditions as set out in the regulatory text be met.
US PR
  • Security options and broad based security index options are out of scope for IM.  Security forwards and forwards on broad based security indices, in each case, that are physically settled are out of scope for IM.
  • Physically settled commodity forwards are out of scope for IM.
US CFTC
  • Security Based Swaps (excluding broad index-based swaps, but including swaps on single name or narrow-based indices) are subject to the US Securities and Exchange Commission’s (SEC) jurisdiction and therefore out of scope of CFTC margin rules.
  • Security options and broad based security index options are out of scope for IM.  Security forwards and forwards on broad based security indices, in each case, that are physically settled are out of scope for IM.
  • Physically settled commodity forwards are out of scope for IM.
JFSA
  • Physically settled commodity transactions are out of scope of IM.
FINMA
  • Single-stock options, equity basket options and similar equity derivatives (e.g. derivatives on equity baskets) are deferred until 4 January 2020.
  • Physically settled commodity derivatives are generally out of scope of IM, but there are certain exceptions should specific conditions as set out in the regulatory text be met.
MAS
  • Securities (including equity derivatives) are carved out from the definition of derivatives contracts under the Securities and Futures Act (SFA) and are therefore currently out of scope for IM.
  • Commodity derivative contracts entered into for commercial purposes are out of scope of IM, subject to the satisfaction of certain criteria set out in the regulatory text.
HK MA
  • Single-stock options, equity basket options and equity index options are out of scope until 29 February 2020.
  • Physically settled commodity forwards are out of scope for IM.
OSFI
  • Physically settled commodity transactions are out of scope for IM.
APRA
  • Physically settled commodity forwards are currently considered in scope  for IM under APRA rules, however these do not usually qualify as derivatives under local legislation and industry bodies are in discussions with the regulator concerning this. Those transactions may subsequently be deemed out of scope at some point in the future.
KFSS
  • IM requirements for equity options are deferred until September 2020.
  • Physically settled commodity transactions are out of scope for IM.

Note that this summary is not exhaustive and the regulatory text should be consulted if further detail is required.

The margin obligations vary between jurisdictions but broadly, there are key requirements which are generally consistent across all regulations. These include:

IM Exchange
  • Collecting and posting of Initial Margin on a gross two-way basis .
  • Under certain rules sets it is important that a counterparty is able to independently validate the call its counterparty is making and has the ability to reconcile and dispute any margin calculations.
IM Calculations
  • When calculating IM, participants can either use the approved and market standard risk sensitivity portfolio model (ISDA SIMM) or the notional based grid method as laid out in the relevant jurisdiction's regulations. Please note that Credit Suisse's preference is to use the ISDA SIMM where allowed for all product types.
Thresholds
  • Application of a capped 'Initial Margin Threshold' at a Group-level between counterparties – which can be allocated in any proportion between individual entities that form part of a group.
  • Application of a capped Minimum Transfer Amount (MTA) across Initial Margin and Variation Margin at counterparty to counterparty level.
Collateral Eligibility
  • Eligible collateral includes cash and non-cash (with the exception of US rules in which only cash is eligible for Variation Margin between a Covered Swap Entity and a Swap Entity). Non-cash collateral tends to include high quality government debt.
  • There are restrictions on collateral eligibility to account for Wrong Way Risk, Concentration Risk and Credit Quality (issuer and rating).
Haircuts
  • Regulators have published a haircut schedule that sets out the minimum valuation adjustment to be applied to collateral. The haircuts vary by maturity, credit rating and security type.
  • An additive FX haircut of 8% applies where the currency of collateral is different to a particular reference currency or currencies, the definition of which can vary by jurisdiction.
Segregation & Rehypothecation of IM
  • Segregation requirements apply for regulatory IM to mitigate risk to the posting counterparty of the collecting counterparty’s default or insolvency;  typically a tri/third-party holding structure with an unaffiliated custodian is required.
  • Generally, rehypothecation of IM is not permitted.
Documentation
  • The above will result in significant documentation requirements, including Credit Support Annexes with regulatory compliant terms and tri/third-party Custodian documentation for segregated Initial Margin.
Transactions
  • Transactions entered into after the relevant compliance date in each jurisdiction will be in-scope for the Initial Margin rules. Whilst transactions entered into before the compliance date are generally excluded, they may be brought into scope when subject to certain lifecycle events.
Further Information
  • For further information on the BCBS IOSCO Uncleared Margin Rules and how they may affect you, please get in touch with your Credit Suisse sales coverage person or email Uncleared.Derivatives@Credit-Suisse.com

Eligible Collateral:

 

HQLA

CS prefers to use a collateral schedule that contains only high quality liquid assets ("HQLA") to ensure transparency in pricing and a level playing field between both parties. By using Credit Suisse’s collateral schedule, we hope to:

  1. Enable effective risk management and the ability to easily liquidate collateral at a market observable price.
  2. Avoid future challenges when agreeing trade novations or an unwind due to idiosyncratic access to non-HQLA collateral.
  3. Align to CCP IM requirements in order to enable smooth transition to clearing.

Risk Management Assessment

The credit quality steps, tenor and haircut schedules provided by the Regulatory Technical Standards ("RTS") are a regulatory minimum. Individual Firms may choose to adjust these to account for internal regulatory capital models and risk appetite assessments.


Margin Approach (IM):

Where a counterparty or client that posts non-regulatory mandated independent amounts (Non Reg IA) comes in scope for initial margin (Reg IM) it is imperative that the parties agree how they will recognise and treat these two margin flows going forward.

The ISDA 2018 initial margin document templates define 3 possible Margin Approaches that can be used to determine the interaction between the amount of Reg IM and Non-Reg IA that will need to be exchanged by in scope parties on a given day. When negotiating a regulatory compliant IM collateral document, the two parties will need to agree to use one of the three approaches for their daily margin calls. The three methods are:

1. Distinct Margin Flow (IM) Approach

  • Parties using the distinct margin flow approach will in general calculate the amount of Reg IM that will need to be exchanged without any interaction with or reference to any Non-Reg IA that is required to be posted
  • The Reg IM collateral process will run in parallel to the Non-Reg IA collateral process with discrete settlement of the two collateral calls for any party that posts both Reg IM and Non-Reg IA (which could be held in the same custodian account if the Non-Reg IA is segregated)
  • The Distinct Margin Flow (IM) Approach can be used irrespective of whether the Non-Reg IA is posted directly to Credit Suisse or segregated at a custodian. There is no requirement for the Non-Reg IA to comply with the IM regulations

2. Allocated Margin Flow (IM/IA) Approach

  • The allocated margin flow approach allows parties to reduce their Non-Reg IA collateral call by the amount of their Reg IM requirement (less any applicable threshold) for trades covered by the same master agreement
  • Collateral documents should be drafted such that non Reg IA covers all relevant transactions, including those covered by the Reg IM collateral document
  • The interaction between the two collateral amounts in the calculation process will generally not affect the settlement process – two discrete collateral amounts will be settled for any party that posts both Reg IM and Non-Reg IA
  • On a daily basis there may be collateral movements required between custodian held regulatory IM and IA held by Credit Suisse
  • The Allocated Margin Flow (IM/IA) Approach can be used irrespective of whether of the Non-Reg IA is posted directly to Credit Suisse or segregated at a custodian. There is no requirement for the Non-Reg IA to comply with the IM regulations

3. Greater of Margin Flow (IM/IA) Approach

  • The “greater of” method consolidates the calculation of Reg IM and Non-Reg IA for one master agreement into a single collateral call per party. This call is calculated as the greater of the Reg IM requirement (less any applicable threshold) and any Non-Reg IA. This is then settled as one collateral call per party (covering both Reg IM and Non- Reg IA) and held at a custodian
  • Collateral documents should be drafted such that non Reg IA covers all relevant transactions, including those covered by the Reg IM collateral document
  • The Greater of Margin Flow (IM/IA) Approach can only be used if: (i) the Non-Reg IA is to be held in the same segregated custodian account as the Reg IM; and (ii) the Non-Reg IA is Reg IM compliant

The choice of which margin approach is the most appropriate for a given relationship will be dependent on a number of factors including;

  1. Operational preference
  2. Whether any Non-Reg IA is exchanged on an existing CSA
  3. Whether any existing collateral is already segregated at a custodian
  4. Whether Non-Reg IA should cover new or only legacy trades going forward
  5. Whether Non-Reg IA is calculated comprehensively on all transactions, only as a fixed amount, or for specific risks not covered by Reg IM

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