Europe Reiterates Rethink on FX Forwards Margining Rules

Three European Union regulators, under the umbrella of the European Supervisory Authorities (ESAs), has released a final report on new draft regulatory technical standards (RTS), which reiterate that the proposal to change the requirements around variation margin (VM) for physically-settled FX forwards and swaps remains in place ahead of the UMR (Uncleared Margin Rules) being lowered to $/EUR 50 million.

The ESAs reiterate that it has become apparent that its own interpretation of the BCBS (Basel Committee on Banking Standards) and IOSCO (International Organisation of Securities Commissions) rules in its RTS was out of sync with other regulators, noting, “The adoption of the international standards in other jurisdictions via supervisory guidance had led to an international scope of application that is more limited than the scope the ESAs had proposed in the RTS (and which was finally embedded in the EU rules).”

The key change is that the ESAs have recognised the requirement “appeared to pose a challenge regarding transactions between institutions and end-users”.

The BCBS-IOSCO Standards state that VM of physically-settled FX forwards and swaps is both an established standard amongst major market participants and a prudent risk management tool that limits systemic risk, and recommend that the rules being imposed at national level – something the EU did at the start of 2018.

Demonstrating legendary speed in dealing with industry concerns, the ESAs note that while the RTS was meant to apply from January 2018, market participants raised their concerns ahead of implementation, which the ESAs analysed. This led, in December 2017, to a proposal to amend the RTS to exempt trades with end-users, however the ESAs state in their latest release, “It can be noted though that the process for the proposed amending RTS from December 2017 has not been completed and thus that it has not become law.”

Notwithstanding the almost four year process to enact this change, the ESAs state, however, that they are of the view that the rationale for the proposed amendment is still valid. It also notes that a rewrite (called a Refit) of the European Market Infrastructure Regulation (EMIR) states, “The need for international regulatory convergence and the need for non- financial counterparties and small financial counterparties to reduce the risks associated with their currency risk exposures make it necessary to set out special risk-management procedures for physically settled foreign exchange forwards and physically settled foreign exchange swaps. In view of their specific risk profile, it is appropriate to restrict the mandatory exchange of variation margins on physically settled foreign exchange forwards and physically settled foreign exchange swaps to transactions between the most systemic counterparties in order to limit the build-up of systemic risk and to avoid international regulatory divergence.”

The upshot of all this is likely to be a formal exemption for end-users of FX forwards and swaps at some unspecified time. Until then, the ESAs have made clear that there is no need to apply VM to end-user trades.