Canada: Margin Requirements For Non-Centrally Cleared Derivatives Issued In Canada

The Office of the Superintendent of Financial Institutions (OSFI), Canada's federal regulator of financial institutions, recently issued Guideline E-22 – Margin Requirements for Non-Centrally Cleared Derivatives (Guideline). The Guideline requires the mandatory exchange of margin for non-centrally cleared derivatives transactions (NCCDs). A draft of the Guideline was published by OSFI on October 19, 2015, and the final Guideline reflects many of the comments submitted during the comment period. Blakes represented the International Swaps and Derivatives Association, Inc. in commenting on the draft Guideline.

The Guideline requires the exchange of margin for NCCDs between "Covered Entities" where at least one of the parties to the NCCD is a federally-regulated financial institution (FRFIs). The Guideline is based on the margin framework for NCCDs established by the Basel Committee on Banking Supervision (BCBS) and the International Organization of Securities Commissions (IOSCO) entitled "Margin requirements for non-centrally cleared derivatives". In specified circumstances, the requirements of the Guideline may be satisfied by following comparable foreign rules that are based on the BCBS-IOSCO framework.

While the broad terms of the Guideline will look familiar to market participants who have experience with the BCBS-IOSCO framework, it does contain a number of features specific to Canada. This bulletin discusses the Guideline and some of the implementation issues that market participants will face.

WHO IS SUBJECT TO THE GUIDELINE?

Subject to certain exceptions, the Guideline is applicable to NCCDs between a FRFI and a financial entity (or a transaction between two FRFIs) where both parties to the transaction qualify as "Covered Entities".

  • FRFIs include OSFI-regulated banks, foreign bank branches, bank holding companies, trust and loan companies, cooperative credit associations, life insurance companies, property and casualty insurance companies and insurance holding companies.
  • Financial entity refers to a legal entity whose main business includes the management of financial assets, lending, factoring, leasing, provision of credit enhancements, securitisation, investments, financial custody, proprietary trading and other financial services activities. OSFI has noted that the definition of financial entity includes (but is not limited to) deposit-taking institutions, insurance companies, pension funds, hedge funds and asset managers.

The Guideline defines a Covered Entity as a financial entity (which would include a FRFI) that belongs to a consolidated group whose aggregate month-end average notional amount of NCCDs for March, April and May (Aggregate Average Notional Amount) in 2016 or any year thereafter exceeds C$12-billion. For purposes of calculating the Aggregate Average Notional Amount, inter-affiliate trades are excluded but physically-settled foreign exchange (FX) forwards and swaps must be included as NCCDs. A consolidated group is a group of entities for which consolidated financial statements are prepared. Investment funds managed by an investment adviser are considered distinct entities that are treated separately when calculating the Aggregate Average Notional Amount so long as the funds are distinct legal entities that are not collateralised by or otherwise guaranteed or supported by other investments funds or the investment adviser in the event of fund insolvency or bankruptcy. FRFIs that qualify as Covered Entities are referred to in the Guideline as Covered FRFIs.

Certain entities are excluded from the definition of Covered Entity under the Guideline and NCCDs with these entities will not be subject to the new margin requirements. These excluded entities include sovereigns, public sector entities (including entities directly or wholly-owned by a government, school boards, hospitals, universities and certain social service programs, as well as municipalities), certain multilateral development banks, treasury affiliates that undertake risk management activities on behalf of affiliates within a corporate group, certain special purpose entities (SPEs) (including certain SPEs used in connection with securitizations, investment funds and real estate holding, in each case that meets prescribed requirements) and central counterparties.

Where an FRFI transacts with a foreign entity that is incorporated or formed under non-Canadian laws, the Guideline permits the FRFI to defer to the margin rules of the foreign entity's jurisdiction to determine whether the counterparty is a Covered Entity provided that certain conditions are met (as further explained below).

OSFI expects FRFIs to self-declare their Covered Entity status to their counterparties prior to entering into NCCDs. They are also responsible for verifying whether or not their counterparties are Covered Entities prior to entering into NCCDs. A Covered FRFI may determine the Covered Entity status of its counterparty by relying on a declaration of the counterparty unless the Covered FRFI has reason to believe the declaration is inaccurate. We expect a standard industry template will be developed to allow parties to disclose their Covered Entity status.

Covered FRFIs must exchange applicable margin with counterparties that are Covered Entities. Margin posting obligations apply to transactions entered into starting September 1 of the year in which the entity becomes a Covered Entity (as determined by applying the Aggregate Average Notional Amount test described above). However, if a party's Covered Entity status changes such that it ceases to be a Covered Entity, no transactions (regardless of when they were entered into) between the parties are thereafter subject to the Guideline's margin requirements.

WHAT TYPES OF TRANSACTIONS ARE SUBJECT TO THE GUIDELINE?

NCCDs include all derivatives not cleared by a central counterparty, other than inter-affiliate derivatives and physically-settled FX forwards and swaps. Derivatives are defined broadly in the Guideline as a financial contract the value of which depends on, or is derived from, the value of one or more underlying reference assets. The term includes forwards, futures, swaps and options, but excludes physically-settled commodity transactions.

As noted above, for the purposes of calculating the Aggregate Average Notional Amount, inter-affiliate transactions are excluded. However, a consolidated group's physically-settled FX forwards and FX swaps must be included even though they are not otherwise in scope for the margin requirements.

MARGIN REQUIREMENTS

If the margin requirements apply to NCCDs between a pair of counterparties, then the counterparties must exchange both initial margin and variation margin bilaterally, in the amount and subject to the terms set out in the Guideline.

Initial Margin

The requirement to exchange initial margin applies as follows:

Determination of Amount – The required amount of initial margin may be determined by reference to either (i) an internal quantitative portfolio margin model; or (ii) the standardized margin schedule set out in the Guideline. The choice between model-based and schedule-based initial margin calculations should be consistent over time for transactions within the same asset class; the Guideline provides that a counterparty may not "cherry-pick" between the two methods. The Guideline sets out rules and minimum standards for the governance, control and design of models.

Collection – Initial margin must be collected on a gross basis, subject to any agreed upon posting threshold not to exceed C$75-million. The threshold is applied at the consolidated group level, based on all NCCDs between the two consolidated groups. For transactions involving a foreign Covered Entity, the parties are able in certain circumstances to apply the initial margin threshold applicable under foreign margin rules in the jurisdiction of the foreign Covered Entity (in lieu of the C$75-million threshold contemplated in the Guideline). In the case of cross-currency swaps, special rules apply to remove the FX portion of the NCCDs for the purposes of determining the amount of required initial margin.

Timing of Call and Exchange – Initial margin must be calculated and called within two business days of the execution of a trade, and thereafter, on a daily basis. Initial margin must be exchanged on or before the second business day following each call for initial margin.

Holding – Initial margin must be held in such a way as to ensure that: (i) it is immediately available to the collecting party in the event of the counterparty's default; and (ii) it is subject to arrangements that protect the posting party in the event that the collecting party enters bankruptcy.

Use – Initial margin cannot be re-hypothecated, although initial margin that is cash may be held in a general deposit account with a custodian in the name of the posting counterparty.

Variation Margin

The requirement to exchange variation margin applies as follows:

Amount – The required variation margin amount is the amount necessary to fully collateralise the mark-to-market exposure of the NCCDs entered into between the Covered Entities.

Collection on a Net Exposure Basis – Variation margin should be calculated and exchanged subject to a single, legally enforceable netting agreement in respect of all NCCDs between the parties. A netting agreement is deemed legally enforceable where:

  • the counterparties have executed a written bilateral netting contract the result of which is a single legal obligation or claim for payment based on the net sum of the mark-to-market values of all netted transactions in the event of a counterparty default
  • the Covered FRFI has conducted a sufficient legal review of the laws of all relevant jurisdictions and has a well-founded legal basis to verify that the netting contract and the determination of a net amount would be upheld in the event of a legal challenge
  • the Covered FRFI has procedures in place to ensure the continuing enforceability of the netting arrangements in light of possible changes in relevant law
  • the netting agreement does not contain a walkaway clause and
  • the Covered FRFI maintains all required documentation

Where a Covered FRFI enters into a netting agreement with a Covered Entity that is not legally enforceable, the Covered FRFI must collect variation margin amounts on a gross basis, but may post variation margin in accordance with the netting agreement.

Timing of Calls and Exchanges – Variation margin generally must be calculated and called within two business days of the execution of a trade, and thereafter, on a daily basis. Variation margin must be exchanged on or before the second business day following each call for variation margin.

Dispute Resolution

A Covered FRFI must have dispute resolution procedures in place with a Covered Entity before entering into NCCDs to address potential disagreements in the calculation of initial and variation margin.

Minimum Transfer Amount of Margin

Margin transfers (combined initial and variation margin) may be subject to a minimum transfer amount not to exceed C$750,000. For transactions involving a foreign Covered Entity, the parties are able in certain circumstances to apply the minimum transfer amount applicable under foreign margin rules in the jurisdiction of the foreign Covered Entity (in lieu of the C$750,000 minimum contemplated in the Guideline).

Eligible Collateral

The following types of collateral are eligible to satisfy the initial and variation margin requirements:

  • Cash
  • Gold
  • Debt securities rated at least:
  1. BB- when issued by sovereigns or public sector entities that are treated as sovereigns by the national supervisor
  2. BBB- when issued by other entities (including banks and securities firms)
  3. A-3/P-3 for short-term debt instruments
  • Unrated bank debt securities listed on a recognized exchange and classified as senior debt where:
  1. All rated issues of the same seniority by the issuing bank are rated at least BBB- or A-3/P-3 by a recognized rating agency
  2. The institution holding the securities as collateral has no information to suggest that the issue justifies a rating below BBB- or A-3/P-3 (as applicable)
  • Equities (including convertible bonds) that are included in a main index or are listed on a recognized exchange
  • Investments in mutual funds and undertakings for collective investments in transferable securities (UCITS) where:
  1. A price for the units is publicly quoted daily
  2. The UCITS/mutual fund is limited to investing in the instruments listed above

Securities issued by the posting counterparty are not eligible collateral.

Haircuts

Haircuts must be applied when valuing margin to account for potential changes in the value of the collateral. Counterparties may compute the haircuts using either an internal model or the standard supervisory haircuts set out in the Guideline. When relying on an internal model, the Guideline provides Covered FRFIs with rules pertaining to the governance and design of their models that must be met.

DEFERENCE TO FOREIGN LAW AND SUBSTITUTED COMPLIANCE

Where a Covered FRFI transacts with a foreign counterparty, the Guideline permits the Covered FRFI to defer to the rules of the foreign counterparty's jurisdiction to determine whether the counterparty is a Covered Entity if (i) the foreign counterparty is not regulated by OSFI and (ii) the Covered FRFI has obtained documentary evidence that the foreign counterparty's jurisdiction has implemented the BCBS-IOSCO margin requirements for NCCDs through published laws, rules or regulations that include the following:

  • the margin requirements in the foreign jurisdiction require the exchange of initial and variation margin for NCCDs between covered entities
  • the phase-in of the margin requirements in the foreign jurisdiction is not any longer than the phase-in under the Guideline and
  • the exchange of margin is subject to minimum transfer amounts and initial margin thresholds that are similar to or more conservative than those under the Guideline

The Guideline permits substituted compliance for a Covered FRFI trading with a foreign Covered

Entity where the Covered FRFI:

  • is required to comply with, and has complied with, the margin requirements imposed on the foreign Covered Entity by a foreign jurisdiction that have been implemented through published laws, rules or regulation and
  • has documentary evidence that the margin requirements of the foreign jurisdiction are comparable to the BCBS-IOSCO margin requirements for NCCDs

The Guideline also permits substituted compliance for the Canadian branch of a bank or insurance company established under the laws of a foreign jurisdiction (Branch) where the Branch:

  • is required to comply with, and has complied with, the margin requirements of the foreign jurisdiction under whose laws the relevant foreign bank or insurance company is established that have been implemented through published laws, rules or regulation and
  • has documentary evidence that the margin requirements of that foreign jurisdiction are comparable to the BCBS-IOSCO margin requirements for NCCDs

We would note that substituted compliance for a Branch appears to be available regardless of whether the Branch is trading with a domestic or foreign Covered Entity (provided the conditions noted above are met). In contrast, substituted compliance is available to Covered FRFIs more generally only where they are trading with a foreign Covered Entity.

PHASE-IN OF MARGIN REQUIREMENTS

The Guideline sets out separate phase-in timelines for the initial margin and variation margin requirements based on the Aggregate Average Notional Amount of both counterparties. As detailed below, the variation margin requirement will be completely phased in by March 1, 2017, and the initial margin requirement will be completely phased in by September 1, 2020. As noted above, for the purposes of calculating the Aggregate Average Notional Amount, inter-affiliate trades are excluded but physically-settled FX forwards and swaps must be included as NCCDs.

September 1, 2016 Initial and variation margin – Any Covered FRFI whose 2016 Aggregate Average Notional Amount exceeds C$5-trillion will be subject to the initial and variation margin requirements when transacting with a Covered Entity that also meets the C$5-trillion threshold.
March 1, 2017 Variation margin – All Covered FRFIs will be subject to the variation margin requirements when transacting with another Covered Entity.
September 1, 2017 Initial margin - Any Covered FRFI whose 2017 Aggregate Average Notional Amount exceeds C$3.75-trillion will be subject to the initial margin requirements when transacting with a Covered Entity that also meets the C$3.75-trillion threshold in 2017.
September 1, 2018 Initial margin - Any Covered FRFI whose 2018 Aggregate Average Notional Amount exceeds C$2.5-trillion will be subject to the initial margin requirements when transacting with a Covered Entity that also meets the C$2.5-trillion threshold in 2018.
September 1, 2019 Initial margin - Any Covered FRFI whose 2019 Aggregate Average Notional Amount exceeds C$1.25-trillion will be subject to the initial margin requirements when transacting with a Covered Entity that also meets the C$1.25-trillion threshold in 2019.
September 1, 2020 Initial margin – All Covered FRFIs will be subject to the initial margin requirements when transacting with another Covered Entity.

The initial and variation margin requirement will apply to all new NCCDs entered into after the phase-in dates referred to above. The margin requirements will not apply to existing (grandfathered) NCCDs, novated grandfathered NCCDs or NCCDs that result from portfolio compression of grandfathered trades.

ANTICIPATED RULE-MAKING BY PROVINCIAL SECURITIES REGULATORS

We understand that provincial securities regulators are working on similar margin rules also based on the framework established by BCBS and IOSCO. While the exact scope of those rules remains to be seen, our hope is that substituted compliance with the Guideline will satisfy the requirements of the provincial rules to the extent the Guideline is applicable. For transactions where substituted compliance with the Guideline is not available, including in particular when Canadian non-FRFIs face non-Canadian banks and swap dealers, the approach in the provincial rules to substituted compliance will be of critical importance.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
 
In association with
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Registration
Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:
  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.
  • Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.
    If you do not want us to provide your name and email address you may opt out by clicking here
    If you do not wish to receive any future announcements of products and services offered by Mondaq you may opt out by clicking here

    Terms & Conditions and Privacy Statement

    Mondaq.com (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

    Use of www.mondaq.com

    You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about Mondaq.com’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.

    Disclaimer

    Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

    The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.

    Registration

    Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

    • To allow you to personalize the Mondaq websites you are visiting.
    • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
    • To produce demographic feedback for our information providers who provide information free for your use.

    Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

    Information Collection and Use

    We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

    We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to unsubscribe@mondaq.com with “no disclosure” in the subject heading

    Mondaq News Alerts

    In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.

    Cookies

    A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

    Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

    Log Files

    We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.

    Links

    This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

    Surveys & Contests

    From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.

    Mail-A-Friend

    If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.

    Emails

    From time to time Mondaq may send you emails promoting Mondaq services including new services. You may opt out of receiving such emails by clicking below.

    *** If you do not wish to receive any future announcements of services offered by Mondaq you may opt out by clicking here .

    Security

    This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to webmaster@mondaq.com.

    Correcting/Updating Personal Information

    If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to EditorialAdvisor@mondaq.com.

    Notification of Changes

    If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

    How to contact Mondaq

    You can contact us with comments or queries at enquiries@mondaq.com.

    If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at problems@mondaq.com and we will use commercially reasonable efforts to determine and correct the problem promptly.

    By clicking Register you state you have read and agree to our Terms and Conditions