United States: Margin For OTC Derivatives: Key Buy-Side Considerations
Last Updated: November 18 2016

15 November 2016

Margin regulations for OTC derivatives will start coming into effect for buy-side market participants in March 2017. These regulations have been adopted by regulators in the United States, the European Union, Japan and Canada, with others expected to follow soon. Each set of regulations has its own scope and requirements. Dealers have begun asking counterparties to sign-up compliant documentation, which will have significant legal, operational and economic consequences.  Market participants need to start preparing now, and cannot afford to wait and see if the new Trump administration and Republican congress may change things.

On November 3, 2016, Cadwalader attorneys who represented the International Swaps and Derivatives Association, Inc. ("ISDA") in the development of industry-standard documentation, gave a webinar addressing issues of particular interest to buy-side market participants.

Five Important Takeaways for Buy-side Market Participants

1. Broad Reach. U.S. margin regulations for swaps and security-based swaps are at least as stringent as parallel non-U.S. rules and apply to virtually all dealers that trade with U.S. counterparties. Therefore, documentation for these counterparties will likely need to comply with U.S. rules regardless of where else their dealer is regulated.  The regulatory experience to date indicates that "substituted compliance" determinations will not provide much relief, as the Commodity Futures Trading Commission ("CFTC")  has taken a very granular approach in comparing regulations.

2. Scope Varies. The scope of products that are subject to regulatory margin requirements varies from one regulatory regime to another.  Therefore, certain products you trade may be out of scope for some dealers but not others.  For example, certain European regulators have indicated that they interpret EU derivatives regulations to cover  "to-be-announced" (or "TBA") transactions, whereas such products are regulated in the same way as securities transactions in the United States and are not subject to swap margin.

3. Consider Costs. Determine how you want to treat legacy and out-of-scope transactions.  Depending on the terms of your current documents, regulatory margin requirements may be more costly than existing arrangements.   But consider these costs against the operational impact of dividing derivatives into separate margin portfolios for in-scope versus out-of-scope transactions under the same Master Agreement.

4. Check Existing Documentation. Modifications you may need to make to your trading documents may be fairly simple if your existing documentation is already substantially in line with the new requirements.  For example, credit support documentation that calls for daily cash variation margin, with no thresholds, and minimum transfer amounts of $500,000 or less, are likely to require few changes, if any.

5. Compliance Will Require Careful Due Diligence. Documentation that complies with applicable regulation(s) can take many forms.  Deciding which one is best for you depends on the state of your existing documentation and whether you want to preserve as much of your existing terms as possible. Adding compliant terms to existing documentation requires careful analysis of the interaction between existing bespoke terms and standardized compliant amendments.

To view our webinar, click here.

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