15 March 2013

EACT/US Coalition submit responses to BIS-IOSCO consultations on Margin Requirements for Non-centrally-cleared Derivatives

The responses highlight that non-financial end-users should be exempt from mandatory margining requirements for OTC derivative trades, or only be required to post margin above a certain threshold.

Introducing mandatory margining requirements would impose unnecessary cost and liquidity burdens to non-financial end-users, which could push some end-users to stop using derivatives which are however essential for corporates to be able to hedge commercial risk. The fact that non-financial end-users' derivative exposures pose little to no systemic risk should be taken into account when drafting the BIS-IOSCO recommendations.

Although EACT primarily represents non-financial businesses, many end-users engage in financial activities as part of their corporate structure that may make them “financial” under the new regulatory regimes, particularly in the US. For example, many end-users have pension funds, captive or non-captive finance affiliates or centralised treasury centres that could be deemed financial under new regulations. Nevertheless, these businesses use derivatives for risk management purposes and not for speculation or investment purposes. Unless otherwise specified, the term “end-users” is used in this letter to refer to both non-financial and financial end-users that use derivatives to hedge risk and that would be subject to the relevant requirements.

The following topics form the content of the response:

Margin for FX Transactions

EACT continues to believe that an exemption that bifurcates forwards and swaps based on tenor will not reduce risk enough to justify the costs of the hedging transactions. If end-users are driven to a strategy that involves rolling or extending short dated products, it will introduce new liquidity risks for end-users each time the short-dated hedge needs to be cash settled. This risk would not exist if end-users are able to time the expiration and cash settlement of their hedge to the timing of the hedged cash flow. In addition, each time an end-user rolls a short-dated hedge, there are additional transaction costs for each roll, multiplying the overall costs to the end-user to hedge long-dated exposures.

Margin thresholds

EACT supports the WGMR’s [Working Group on Margining Requirements] proposal to recommend initial margin thresholds below which covered entities are not required to post margin. It believes this will reduce the substantial liquidity burden associated with initial margin without undermining WGMR’s objective of mitigating systemic risk. EACT urges the WGMR, however, to provide a threshold below which non-systemically important financial end-users would not be required to post variation margin for hedging transactions.

Re-hypothecation

EACT urges the WGMR to consider taking action that  would limit indirect costs imposed on end-users, including the following:

• Permit re-hypothecation in limited circumstances: permitting re-hypothecation of  collateral when it is posted to secure positions used to offset a hedge of commercial risk for an end-user.
• Eliminate initial margin in limited circumstances: eliminating initial margin requirements imposed on covered entities when such initial margin would otherwise be applied to transactions used to hedge exposures that arise when a counterparty hedges risk associated with an end-user hedging position. EACT believes this would similarly serve to  limit indirect costs that could deter end-users from hedging or unnecessarily increase their costs.

Phase-in of Requirements

EACT strongly supports the WGMR’s recommendation that the margin requirements should not be applied retroactively, and should be applied only to those trades entered into after the requirements take effect.

EACT believes, however, that the WGMR should also propose a phase-in period for the introduction of variation margin requirements. Although variation margin requirements may be standard practice for large or systemically important market participants, as previously noted, many end-users currently do not post variation margin.

Full response

 

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