The new margin requirements will complement other G-20 measures to reduce the systemic risk imposed by the over-the-counter (OTC) derivatives market that have been in development since 2009.
The Basel Committee on Banking Supervision and the International Organization of Securities Commissions (IOSCO) last week published a consultative paper on margin requirements for non-centrally-cleared derivatives. The paper follows a commitment made by the G-20 last year to establish a framework for mandatory posting of collateral as security to support the obligations of parties to non-centrally-cleared derivatives transactions.
The new margin requirements will complement other G-20 measures to reduce the systemic risk imposed by the over-the-counter (OTC) derivatives market that have been in development since 2009. These include mandatory central clearing and electronic trading of standardised OTC derivatives, and trade reporting of all OTC derivatives contracts (see our recent article on the Australian Government's proposed implementation of these reforms).
Objectives of proposed margining requirements
Margin requirements for non-centrally-cleared derivatives have been proposed to reduce systemic risk caused by, amongst other things, a build-up of uncollateralised exposures within the financial system. The paper also contemplates that imposing margin requirements on non-centrally-cleared derivatives will promote central clearing, in support of the G-20's original 2009 reform program.
Key elements of the proposals
The key elements of the margining reforms proposed in the paper are:
- margining requirements will apply to all derivative products with no exceptions;
- derivative contracts will only be caught if they are entered into by financial or systemically important entities (but not including sovereigns or central banks). There is no guidance as to what would constitute a systemically important entity;
- to ensure consistency of margin calculations across entities, a schedule of standardised margin calculations is proposed in the paper, along with proposals to allow participants to maintain their own models for margin calculation under the supervision of national regulators;
- posted collateral must be highly liquid, while still allowing some flexibility to minimise the impact on individual liquidity positions. The paper proposes a non-exhaustive list including (with appropriate haircuts) cash, government bonds, high quality corporate bonds, covered bonds and equities and gold;
- the margining terms must allow the collateral to be available to the party holding the collateral, immediately following a counterparty default; and the party that posted the collateral, following the insolvency of the other party; and
- there must be consistency between jurisdictions in the implementation of margining requirements.
Quantitative impact study to assess the impact of margin requirements on liquidity
The Basel Committee and IOSCO recognise that the potential benefits of margin requirements must be weighed against their liquidity impact and other costs, which they anticipate could be significant. The Basel Committee and IOSCO will therefore conduct a quantitative impact study (QIS) in order to gauge the liquidity impact of the margin proposals.
Implications for Australia
Given Australia's membership of the G-20, the Basel Committee and IOSCO, it is expected that our national regulators will give serious consideration to the implementation of the proposed margining reforms in Australia once they have been finalised.
The chairman of the Australian Securities and Investments Commission, Greg Medcraft, is currently chairman-elect of IOSCO and is on record as wanting to make IOSCO "the key global reference body for securities regulation, in much the way the Basel Committee is seen for banking regulation and supervision."
Responses to the public consultation, together with the QIS results, will be considered in formulating a final joint proposal on margin requirements for non-centrally-cleared derivatives by the end of 2012.
Comments on the proposed policy are due by Friday, 28 September 2012 by e-mail to: firstname.lastname@example.org and/or email@example.com. If you are interested in contributing to the consultation process and would like our assistance please contact Louise McCoach, Graeme Dennis, or Alex Chernishev.
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Clayton Utz communications are intended to provide commentary and general information. They should not be relied upon as legal advice. Formal legal advice should be sought in particular transactions or on matters of interest arising from this bulletin. Persons listed may not be admitted in all states and territories.