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New margin requirements for non-centrally cleared derivatives

The global financial crisis has raised important questions regarding the regulation of derivatives trading. Policymakers and market participants have sought to develop an enhanced framework for financial activity. This newsletter aims to provide insight on the different requirements implemented through the latest derivative trading regulations along with their implications.


In September 2009, the G20 Pittsburgh summit committed to improving transparency in the derivatives markets, mitigating systemic risk, and preventing market abuse. Three major strategic initiatives resulted from this consensus:

1. Reporting of all derivatives transactions to centralized trade repositories, allowing regulators to have a greater insight over the market.

2. Centralization of OTC derivatives clearing, made mandatory for standardized transactions and incentivized through capital requirements for others, in order to reduce systemic risk in the markets.  Essentially, clearing houses will spread the risk of any one member’s default among all the other members.

3. New margin requirements for non-centrally cleared derivatives, defined in order to minimize the risk of market contagion.

  • The initial margin protects the transacting parties from the potential future exposure from future changes in the mark-to-market value of the contract during the time it takes to close out and replace the position in the event that the counterparty defaults.
  • The variation margin protects the transacting parties from the current exposure from changes in the mark-to-market value of the contract after the transaction has been executed.

While the reporting and central clearing requirements have been largely enforced by Regulators (especially in the U.S.), the new margin requirements for uncleared swaps are yet to be finalized and enforced (as required under sections 731 and 764 of the Dodd-Frank Act in the U.S.).

On October 22, 2015, the Office of the Controller of the Currency (OCC), Federal Deposit Insurance Corporation (FDIC), Federal Reserve Board (FRB), Farm Credit Administration (FCA), and the Federal Housing Finance Agency (FHFA) have adopted a joint rule to establish capital requirements, initial margin, and variation margin requirements on all non-cleared swaps and non-cleared security-based swaps. On December 16, 2015, the Commodity Futures Trading Commission (CFTC) has also published its final rule.

A final rule from the Securities and Exchange Commission (SEC) is still expected.

The next chapters of this newsletter intend to give an overview of the requirements adopted by the regulators on October 22, and anticipate their impact.

Overview of new margin requirements

Scope of requirements

The adopted requirements apply to swap and security-based swap transactions that are not cleared. The “non-cleared swap” definition includes any swap that is not cleared by a Derivatives Clearing Organization (DCO) registered with the CFTC or by a clearing organization that the CFTC has exempted from registration by rule or order. The “non-cleared security-based swap” definition includes any security-based swap that is not, directly or indirectly, submitted to and cleared by a clearing agency registered with the SEC or by a clearing agency that the SEC has exempted from registration by rule or order.

Such a definition will allow covered entities to exclude transactions made with non-U.S. clearing organizations that are subject to “comparable, comprehensive supervision and regulation” in their home country, if, as expected, the CFTC and SEC grant relief from registration to these DCO.

The requirements apply to all Covered Swap Entities (CSE).

These include:

  • Persons/entities that have registered with the CFTC or the SEC as Swap Dealers (SD) or Major Swap Participants (MSP)
  • Financial End Users: entities whose business is financial in nature (e.g. insurance companies, State-licensed or registered credit or lending entities and money services businesses, real estate investment companies, securitization vehicles…).
    *This includes U.S. Intermediate Holding Companies.

Excluded from this definition:

  • Financial end users without material swaps exposure (any entities whose average daily aggregate notional amount of non-cleared derivatives including covered swaps, covered security-based swaps, foreign exchange forwards and foreign exchange swaps) with all counterparties for June, July and August of the previous calendar year, aggregated at the highest consolidation level, below $8 billion, will be exempted to comply with these new margin requirements.
  • Non-financial end users (any entity that is not an SD, an MSP, nor a financial end user);
  • Supervised institutions with assets of $10 billion or less.
  • Sovereigns and multilateral development banks.

Baseline minimum amounts and methodologies for initial and variation margin

Initial and variation margin payments or collections would not be required to be made if the payments were below the Minimum Transfer Amount ($500,000). This statement aims at reducing transaction costs. 

The CSE is required to collect Initial Margin (IM) from, and to post Initial Margin to, each covered counterparty, on or before the business day following the day of execution, and until the swap expires or is terminated. The required amount of IM can be calculated using either a model-based method or a standardized table-based method.

  • The required amount of IM would be the amount computed minus a threshold amount of $50 million. This threshold is calculated at the highest consolidation level of both parties and is based on all non-exempted non-cleared swaps between the two consolidated groups (see picture 1).
  • IM have to be fully exchanged.
  • For transactions of a portfolio subject to the same netting agreement:
    * Under the model-based method, IM may be netted per "broad risk category", but not across broad risk categories. The four broad risk categories are: commodities, credit, equity, and foreign exchange/interest rates.
    * Under the standardized method, IM may be netted across all asset classes.

*Initial Margin requirements don’t apply to the portion of a cross-currency swap that is the fixed exchange of principal.

The CSE is required to collect Variation Margin (VM) from, and to post Variation Margin to, each counterparty that is a swap entity or a financial end user, on or before the end of each business day following the day of execution of the swap and until the swap is terminated or expires.

  • A bilateral threshold requirement applies to all financial end users regardless of whether the entity had material swaps exposure.
  • VM may be netted across swaps if executed pursuant to an eligible master netting agreement (which creates a single obligation for all covered transactions upon an event default of the counterparty following any permitted stays in insolvency).

Eligible collateral

The OCC and FDIC provide a clear definition of the eligible collateral for IM and VM.

Eligible collateral for IM includes cash, certain domestic debt securities (issued or guaranteed by the U.S. Department of Treasury or by any other U.S. government agency, the International Monetary Fund, the European Central Bank, Multilateral Development Banks certain U.S. GSE), certain foreign government debt securities, certain corporate debt securities, certain listed equities, and gold.

Eligible collateral for VM depends on the type of counterparty.

  • When facing another swap entity, only immediately available cash (denominated in USD, another major currency, or the swap settlement currency) can be used.
  • When facing financial end user counterparty, any collateral eligible to IM can be used.

Treatment of collateral

A CSE that collects or posts IM shall require that one or more custodians, which are in no way affiliated with either party, hold such collateral.

The custodian agreement must prevent rehypothecation or repledging and must be enforceable, including in bankruptcy. However, the custodian agreement may permit reinvestment of the funds into assets that would qualify as eligible collateral.

Affiliate transactions

The adopted requirements include a few special rules that can potentially affect the requirements when applied to affiliate transactions:

  • A covered swap entity is not required to post IM to an affiliate that is not also a covered swap entity.
  • Each affiliate may be granted an IM threshold of $20 million.
  • A covered swap entity, or an affiliate, that collects non-cash collateral can serve as the custodian.
  • A holding period of five business days or the maturity of the portfolio may be used in the margin model for any swaps with an affiliate, provided that the IM is calculated separately from the other swaps.

Phase In

In the final rule, the Regulators have slightly loosened the terms of the phase-in period.

The requirement to exchange variation margin will become effective on September 1, 2016 for when both the covered swap entity and its counterparty have an average daily aggregate notional amount of covered swaps for March, April and May of 2016 that exceeds $3 trillion. Any other covered swap entities with respect to covered swaps with any other counterparty will have to comply with the variation margin requirement by March 1, 2017

The initial margin requirement will apply in priority to the largest, most active and most systemically important derivatives market actors. To that intent, the application threshold (defined as the month-end average notional amount of non-centrally cleared derivatives computed at the highest consolidation level) will be gradually lowered, starting from $3 trillion. To be identified as a covered entity, the average daily application threshold should be exceeded over March, April and May. If so, the entity will be subject to these new margin requirements during the one-year period from September 1 of that year to October 31 of the following year.

The new requirements will only apply to new contracts entered after these dates. Treatment of prior contracts will be agreed as per private bilateral negotiations.


According to the FDIC, following the implementation of this new rule, financial institutions and their counterparties are expected to be required to post an additional $315 billion of collateral to cover their non-cleared swaps.

The degree of impact will mostly depend on the type of entity

The new margin requirements will influence differently the activity of the different market players. Swap Dealers will be the earliest and most significantly impacted by the regulation. Globally, they will require more capital, as the operational and financial costs of transactions will rise. Depending on their organization, Swap Dealers may opt to review their corporate structure, in order to optimize their affiliate transactions.

Major Swap Participants and Financial End Users, as they face many of the same requirements as Swap Dealers, are expected to follow the same activity review as Swap Dealers. However, it is worth noting that under these new constraints, small market players and new market entrants may develop competitive advantages and therefore address niche markets.

Finally, although non-financial and commercial end users are excluded from capital and margin requirements, they will likely be impacted by the rise in end-user prices reflecting the cost increases induced by this new regulation in the overall value chain.

Application and Initial Margin materiality thresholds

Strategic arbitrage opportunities in activities might be available based on the application calendar and Initial Margin thresholds. Daily margining may be onerous for smaller participants, as some do not have the infrastructure and capacity to manage such process.  Additionally, many buy-side portfolios are directional and will therefore require high margin requirements.  Finally, the requirement to compute these thresholds at the highest consolidation level and on a daily basis may require structural evolutions in the underlying systems and lead to a rationalization and reconsideration of activities.  

Initial Margin exchange and collateral eligibility

The costs of assets considered eligible for collateral are likely to significantly increase due to a rise in the demand reinforced by the full two-way collect-and-post regime imposed on Initial Margin.

Given that the two-way exchange is not a current common market practice, market participants are expected to have to make significant investments in their collateral infrastructures and capabilities (legal and operational).

Management of multiple agreements

These new requirements only apply to trades executed after the application date, thus allowing participants to support both pre and post eligible master netting agreement (EMNA), as the current standards are less punitive. This will further increase systems’ complexity. Additionally, the legal impact will also be quite significant, as it may require repapering a huge amount of contracts and agreements.

Restrictions on re-hypothecation

The restrictions on the rehypothecation of customers’ collateral will require entities to review their business and technology models. These limitations will also reduce the pool of eligible collateral, further pressuring a potential collateral squeeze.


Segregation rule

As participants are required to segregate received Initial Margin from their assets and other clients’ assets, the operational complexity of custody will rise significantly (multiple legal agreements with different custodians, new enhanced reporting on collateral, less flexible substitution mechanisms).


Please find here the full version of the article for further reading. 

Sia Partners

Copyright © 2015 Sia Partners. Any use of this material without specific permission of Sia Partners is strictly prohibited.

  • Key Takeaways

    Covered swap entities will face two major challenges:

    • Operational complexity will increase as covered entities will have to manage a larger diversity of agreements, subject to a greater number of constraints, and involving new actors. Systems and processes reconfiguration will represent a significant cost in order for covered entities to comply with this new regulation. Furthermore, differences and possible inconsistencies between home regulations might affect cross border activities.
    • The OTC derivative market will certainly experience a collateral squeeze. Due to the strict collateral eligibility criteria and the restrictions enforced on re-hypothecation, the demand in collateral and consequently their prices will likely rise significantly.


  • Full version of the article

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