Three federal bank regulators released interagency guidance on the regulatory capital treatment of centrally cleared "settled-to-market" derivative contracts.
Staffs of the Office of the Comptroller of the Currency ("OCC"), the Board of Governors of the Federal Reserve System ("FRB") and the FDIC (collectively, the "Agencies") issued guidance in response to a request from supervised institutions for clarification regarding the recognition of "settled-to-market" contracts under the regulatory capital rules of the Agencies. In the guidance, the Agencies explained that certain central clearing counterparties have changed their rules in order to treat daily variation margin transfers for cleared derivatives contracts as full daily settlements of amounts owed under those contracts, rather than deliveries of collateral securing open exposures. As noted, the rules governing the "standardized approach" to risk-based capital and the supplementary leverage ratio derive requirements from calculations of open current exposures and potential future exposures. In turn, a potential future exposure is derived partly from a contract's remaining time to maturity. The Agencies affirmed that for the purposes of these rules, if the legal and accounting analysis of a "settled-to-market" contract establishes that any outstanding exposures are actually settled, and the terms of the contract are reset to have a fair value of zero, then the remaining maturity of the contract on each day can be deemed to be the time until the next variation payment (i.e., one day) rather than the time until final termination.
The Agencies also provided guidelines for conducting the required analysis, and noted that supervised institutions should evaluate (i) whether all legal claims to the variation margin are relinquished by the transferor, (ii) whether a full transfer of ownership has occurred, and (iii) any other applicable agreements, including whether satisfying additional obligations is required in order to recognize a transfer settlement.
Commentary / Jeff Robins
From an economic or credit standpoint, there is little practical difference between unsegregated cash variation margin transfers under the "collateralized-to-market" and "settled-to-market" rule sets. The difference in the Agencies' capital treatment of transactions under the two types of clearing rules reflects a line-drawing illogic, at least from an economic perspective. The move of clearing counterparties from "collateralized-to-market" rule set to the "settled-to-market" rule set was undertaken for the purpose of allowing market participants to avail themselves of the better capital treatment. The Agencies' guidance is helpful in providing assurance that it is permissible to elect the clearing rule set that provides better capital treatment, and the Agencies' guidance is notably grounded in legal rather than economic terms.
Nevertheless, market participants should carefully consider the rules of each clearinghouse providing "settled-to-market" variation margin to be confident that those rules meet the requirements to obtain favorable capital treatment.
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