Australia: At the margin - draft new requirements for non-centrally cleared OTC derivatives

Key Points:

Draft Prudential Standard CPS 226 is designed to stem risk and contagion in non-centrally cleared derivatives through risk management and margining, but sets the qualifying threshold at a level which is unlikely to affect a large proportion of entities who deal in OTC derivatives.

The Australian Prudential Regulation Authority (APRA) released its draft Prudential Standard CPS 226 on 25 February 2016. The draft standard represents the final pillar of Australia's G20 commitment to implement a broad reform agenda for OTC derivatives which was agreed to at the 2009 Pittsburgh Summit and later supplemented in November 2011 by G20 Leaders in Cannes. The final pillar is aimed specifically at APRA regulated entities including Authorised Deposit-Taking Institutions (ADIs), general insurers and life companies. The standard aims to align the Australian regulations with the with the margin requirements and risk mitigation standards outlined by the Basel Committee on Banking Supervision (BCBS) and the International Organisation of Securities Commission (IOSCO).

Broadly, CPS 226 seeks to reduce systemic risk and contagion effects in the OTC derivatives market by ensuring the availability of collateral to offset losses that may otherwise be caused by the default of a derivative counterparty. Keys aspects include:

  • the requirement to post and collect variation margin;
  • the requirement to exchange a two-way initial margin on a gross basis;
  • the requirement to collect eligible collateral as margin and apply haircuts on collateral; and
  • a framework for alignment with foreign margining regimes based on the BCBS-IOSCO framework.

Who is impacted?

Draft Prudential Standard CPS 226 is proposed to apply to ADIs (including foreign ADIs regulated in Australia), general and life insurers, friendly societies and registrable superannuation entities. However, covered bond SPVs and securitisation SPVs that enter into derivative transactions for the sole purposes of hedging are excluded from the application of the standard, the result of successful lobbying by securitisation industry participants. The argument for exclusion is the benefit of security structures and the senior ranking in transaction cashflows that swap counterparties who transact with securitisation special purpose vehicles benefit from.

While the principles of CPS 226 are broadly stated, APRA has proposed significant thresholds for some of the requirements, stating that it has sought to find an appropriate balance between the objectives of financial safety and efficiency, competition, contestability and competitive neutrality.

Margin requirements

APRA proposes that CPS 226 will require all APRA covered entities that engage in non-centrally cleared derivatives to exchange margin with covered counterparties (ie. a financial institution or systemically important non-financial institution) to cover changes in the current value and potential future exposure of derivatives that are not cleared by a central counterparty. These margins consist of a variation margin and an initial margin:

  • a variation margin is required to be exchanged where an APRA covered entity enters into a transaction with a covered counterparty, where each party belongs to a margining group that has non-centrally cleared derivative activity in excess of a qualifying level. The qualifying level is designed to limit the competitive impact and costs imposed on entities that transact fairly limited amounts of non-centrally cleared derivatives for hedging purposes (see below).
  • an initial margin is required to be exchanged to protect counterparties to a non-centrally cleared derivative against the potential future exposure that may rise from future changes in the mark-to-market value of the derivative during the period of time that is assumed to be required to close-out and replace positions following a counterparty default, subject to the qualifying levels below.


Reference Period

Qualifying Level

Margining Period



Variation Margin

March, April and May 2016

AUD 4.5 trillion

1 September 2016 to 28 February 2017

September, October and November 2016

AUD 12 billion

1 March 2017 to 31 August 2017

From March 2017, March, April and May of each year

AUD 3 billion

1 September of each year to 31 August of the next calendar year





Initial Margin

March, April and May 2016

AUD 4.5 trillion

1 September 2016 to 31 August 2017

March, April and May 2017

AUD 3.375 trillion

1 September 2017 to 31 August 2018

March, April and May 2018

AUD 2.25 trillion

1 September 2018 to 31 August 2019

March, April and May 2019

AUD 1.125 trillion

1 September 2019 to 31 August 2020

From March 2020, March, April and May of each year

AUD 12 billion

1 September of each year to 31 August of the next calendar year

APRA proposes that the frequency and exchange of calculations for variation margin will be daily, whereas an initial margin will be exchanged and calculated at the outset of a transaction and on a regular and consistent basis upon changes in the measured potential future exposure. The model used to determine the necessary calculations must be approved by APRA (or be the standardised model set out in Annexure A of CPS 226).

APRA has also listed certain types of collateral suitable for margining, such as cash collateral, certain government and ADI issued debt securities, covered bonds, senior securitisation exposures and equities included in a major stock index, and gold bullion.

Risk Mitigation Standards

  • As outlined in the draft CPS 226, APRA also seeks to introduce certain risk mitigation measures such as:
  • the execution of written trading relationship documentation;
  • implementation of policies and procedures to ensure:
    • materials terms are confirmed;
    • material terms and procedures are reconciled; and
    • regular assessment and engagement of portfolio compression; and
  • agreement on the mechanism or process for determining when discrepancies in material terms or valuations should be considered disputes, and how those disputes should be resolved.


The draft CPS 226 is aimed at entities that deal in high volumes of OTC derivatives and is aimed to align Australian regulation of OTC derivatives with international equivalents. You will need to determine if this standard will apply to you, implement the required policy and procedures and documentation to ensure you are in position to post and receive collateral in accordance with these requirements.

Once implemented, some aspects of CPS 226 may also impact on non-regulated OTC derivative counterparties. They should be familiar with the standard as they may be required to provide representations and warranties to the regulated counterparties or implement internal procedures in response to the risk mitigation requirements imposed by CPS 226.

The draft CPS 226 is available for comment until 20 May 2016.

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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.

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