Exchange of collateral with respect to OTC derivatives contracts of financial counterparties to become mandatory
New provisions on collateral posted for bilateral OTC derivatives and on other risk management procedures are included in the Commission Delegated Regulation (EU) 2016/2251 published on 15 December 2016. The Delegated Regulation specifies the provisions of Article 11 of the Regulation (EU) No 648/2012 (EMIR). A key purpose of the new provisions is to mitigate the mutual counterparty credit risk between the parties to OTC derivatives contracts.
Directly applicable legislation
The Delegated Regulation is part of directly applicable EU legislation. The Regulation will take effect on 4 January 2017, and it will be applied in accordance with the timeframes set out in the Regulation. The Regulation will affect, in particular, financial counterparties, such as banks, insurance companies, investment firms, investment funds and alternative investment funds in accordance with Article 2 (8) of the EMIR. In addition to financial counterparties, the Regulation will also apply to a limited number of non-financial counterparties exceeding the clearing threshold.
Key content of the reform
For users of OTC derivatives, the key aspects of the reform are:
- the obligation to agree on exchange of collateral in the manner laid down in the Regulation
- the obligation to agree on the assets used as collateral prior to conclusion of new OTC derivatives contracts
- the obligation to use the types of collateral set out in the Regulation
- the obligation to manage the risks related to OTC derivatives and the collateral posted for them in accordance with the provisions of the Delegated Regulation.
Broadly-based obligation to exchange collateral
The Delegated Regulation divides collateral into variation margins and initial margins. The obligation to exchange variation margins mainly concerns all bilateral OTC derivatives contracts of financial counterparties. This obligation will apply to OTC derivatives contracts entered into on or after 1 March 2017. The obligation will apply, as early as February, to a small number of financial counterparties with a particularly high volume of OTC derivatives contracts. In practice, these are mainly international banks.
Obligation to exchange initial margins to be phased in
In addition, large market participants with over EUR 8 billion worth of OTC derivatives contracts, calculated in terms of gross notional amounts, will be subject to an obligation to exchange initial margins. This obligation will be applied gradually on the basis of the total volume of contracts in such a way that the first counterparties will fall within the sphere of the exchange obligation in February 2017 and the last ones on 1 September 2020.
Extension of time for equity and equity index derivatives and intra-group OTC derivatives
As for OTC equity and OTC equity index derivatives, the obligation to exchange collateral will not apply until the beginning of 2020. Moreover, there will be a transitional period of six months until 4th of July for the application of the collateral exchange obligation to intra-group transactions according to Article 3 of the EMIR of groups as defined in Article 2 (16) of the EMIR.
Exemptions for intra-group OTC derivatives
The obligation to exchange collateral will not be applied to such bilateral OTC derivatives contracts according to Article 3 of the EMIR, entered into by two counterparties belonging to the same group and established in the same Member State, as also meet the requirements under Article 11 (5) of the EMIR. Counterparties belonging to the same group and established in different Member States can also apply for exemption in accordance with Article 11 of the EMIR. More detailed provisions on applications for exemption are laid down, in addition to the Regulation now published, in the Commission Delegated Regulation (EU) No 149/2013.
For further information, please contact
Arja Voipio, Chief Infrastructure Expert, arja.voipio(at)fiva.fi or +358 10 831 5224 .