The Board of Governors of the Federal Reserve System ("FRB"), the Office of the Comptroller of the Currency ("OCC"), European Supervisory Authorities ("ESAs") and the IOSCO Board responded to industry concerns about the March 1, 2017 implementation deadline of variation margin requirements.
The FRB and OCC statements acknowledge the scope and scale of the changes that are required for compliance with the new variation margin rules, and set out principles that examiners are expected to use when determining compliance during initial examinations. The principles include the following:
- Covered swap entities are expected to be in full compliance with respect to counterparties that are swap entities and financial end users "that present significant exposures" as of March 1, 2017.
- With respect to other counterparties, the examinations should be risk based, and the focus should be on good-faith efforts to comply with the rules as soon as possible and in no case later than September 1, 2017.
- Examiners should evaluate management systems and overall programs for compliance, and consider a swap entity's implementation plan, including actions to be taken to update documentation, policies and procedures, and staff training.
- A covered swap entity is expected to have risk-based governance processes that assess and manage potential and present swap exposures and any other market risks.
The statement by the ESAs notes that neither they nor the "competent authorities" ("CAs") have the formal authority to grant an extension of the deadline for compliance with EU rules at a national level. Nevertheless, the ESAs state, they "expect" CAs to apply their supervisory and enforcement powers in a risk-based manner while taking into account the size of any exposures in relationships that are not fully compliant, as well as alternative arrangements to contain risk that may have been employed.
Lastly, the IOSCO Board expressed its concern that the public response to the industry's reported lack of readiness could lead to market disruption. The Board advised member states to consider measures that would ensure fair and orderly markets.
Commentary / Jeff Robins
Although clearly calibrated to exert maximum pressure on market participants, the statements by U.S. and European regulators are welcome. Despite massive efforts, industry participants have reported relatively low numbers of relationships that are fully compliant with the detailed and often murky requirements of the new margin rules. For that reason, it is heartening that regulators finally are endorsing a risk-based approach to judging compliance and creating some space to avoid a major market break.
Derivatives dealers and their counterparties now should concentrate on using this very limited time before March 1 to finalize documentation for relationships that create the largest exposures.
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.