Dealers Face Uncertainty Over Uncleared Swaps

Terry Flanagan

Swap dealers are facing new rules for calculating margin for uncleared swaps, i.e., those swaps that are executed and settled bilaterally rather than being centrally cleared.

The Basel Committee on Banking Supervision and the International Organization of Securities Commissions have established a December 2015 deadline for national regulators to come up with rules that conform to guidelines issued by BCBS/Iosco in September of last year for calculation of initial margin and variation margin.

“You have one set of guidelines and multiple sets of rules,” said Gerardo Talamo, vice president and counsel at AllianceBernstein, at the TSAM New York conference on Thursday. “BCBS/Iosco came out with a framework in September last year, the purpose of which is to come out with minimum standards around margin for uncleared swaps.”

In February 2014, the Europeans came out with rules, and prior to the BCBS/Iosco framework being finalized, the SEC, CFTC, and bank regulators in the U.S. came out with their own proposed rules. “Nothing is final, except the framework, which puts forward minimum standards,” Talamo said.

The issue is further complicated by whether an entity is classified as a swap dealer. The Commodity Futures Trading Commission has determined that if an entity is guaranteed by a U.S. person, it would be subject to the swap dealer test.

“After that determination came out, we saw a spike in registrations of affiliates of banks in non-U.S. locations as registered swap dealers,” said Michael Brosius, vice president of the National Futures Association. “The CFTC also determined that if a transaction was negotiated or executed within the U.S., even if that entity was non-U.S, it would be subject to the U.S. transaction rules for swaps. That was unexpected and the subject of a lawsuit.”

Another complication is that the same transaction could be subject to different margin rules. In Europe, variation margin will be required for both uncleared non-deliverable FX forwards and deliverable FX forwards. In the U.S., NDFs must be cleared but deliverable forwards will not be cleared because the Treasury exempted them from clearing requirements.

“In the U.S., deliverable FX was carved out by the Treasury,” said Talamo. “So right away you have a potential issue or mismatch in how markets will work. You might have a situation where variation margin is required for deliverable forwards in Europe but not the U.S.”

The International Swaps and Derivatives Association’s Working Group on Margin Requirements (WGMR) has developed a methodology for initial margin which could be used by market participants.

“The WGMR is working on how to do this,” Talamo said. “It’s difficult in the absence of final rules, but they are talking conceptually about a protocol that requires a new CSA [credit support annex]. Potentially you could have two CSAs attached to the same entity.”

A common methodology would have several benefits to the market, the WGMR said in a report last December, such as permitting timely and transparent dispute resolution and allowing consistent regulatory governance and oversight. In order to realize these benefits, agreement between market participants and global regulators on several key assumptions will be required.

Methodologies used for capital calculations are not appropriate for initial margin for non- cleared derivatives, the WGMR said, noting that the first main objective outlined by the final guidelines, “reduction of systemic risk,” is different than the general aim of capital calculations regularly employed on similar portfolios by regulated institutions.

Featured image via Dollar Photo Club

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