IM Legacy Labyrinth
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ISDA has identified potential differences in global Regulators’ approach to the treatment of legacy trades as firms move in and out of the initial margin regime following the AANA calculation. The IM rules are now fully phased-in, albeit with a large proportion of counterparties in the Threshold Monitoring waiting room. IM therefore becomes a BAU cycle in which firms complete their AANA calculation to determine their continuing inclusion. If a firm’s notional amount falls below the 8bn. threshold, they will no longer be under the obligation to exchange IM, at least until their next AANA recalculation. The question is, having dropped out, are “legacy” trades still subject to IM requirements. The US Prudential Rules are relatively clear[1], although citing the material exposure threshold as the trigger for a change in IM status, all swaps new and old are affected. ISDA believe that the following Regulators are similarly unambiguous: CFTC, Canada’s OSFI, Hong Kong’s HKMA, and Brazil’s BCB. They further conclude that the position is also sufficiently transparent under: Hong Kong’s SFC, Japan’s JFSA, the Financial Services Commission (FSC), the Swiss Financial Market Supervisory Authority (FINMA, Saudi Arabia’s SAMA and South Africa’s FSCA and SARB.
The situation is more complex for the UK, EU, Singapore and Australia. Singapore’s MAS and Australia’s APRA rules state that if a transaction is subject to IM at its inception, the requirement will persist for the life of the transaction. Although entirely dissonant with global norms, the situation in these two jurisdictions is at least relatively clear. By contrast, in the UK and EU EMIR Art. 28 states that having dropped through the 8bn threshold, there is no obligation for IM to be “collected for all new OTC derivatives contracts entered into within a calendar year”, making no reference to existing trades. On a plain reading, legacy trades will continue to be subject to margin requirements, transactions within the non-IM period will not be subject to IM at all. As firms continually adjust their uncleared/non-cleared portfolios, expand and contract trading activity and recalibrate fund profiles, it is likely that over time, firms will regularly drop in and out of the IM regime. If they are subject to any of these four jurisdictions, portfolios will be split according to whether trades are liable to IM, posing a significant challenge in operational complexity and portfolio management. Ensuing complexity is compounded for cross-border trades i.e. US-EU. The US counterparty to a legacy trade will not be subject to IM, the EU counterparty will be. Counterparties facing this prospect will be incentivised to simply terminate the affected trades and reinstate them in a more IM legacy friendly jurisdiction. Similarly, in order to avoid portfolio bifurcation counterparties within the affected jurisdictions i.e. UK-EU, may simply tear up their legacy trades, effectively “bed and breakfasting” into the non-IM period. The majority approach reflects BCBS/IOSCO guidelines that the uncleared margin rules are intended to mitigate systemic risk, as well as EMIR Art. 28 stated intention to apply IM to systemically-important entities.
In summary, these four jurisdictions have rules that are inconsistent with global norms, potentially create an operational migraine and are relatively easy to evade. It seems likely that this Regulatory dissonance is the result of either poor drafting, lack of foresight or both on the parts of the EU, Singapore and Australia, as well as another post-Brexit unfortunate inheritance for the UK. ISDA has written to each of the Regulators requesting clarification and urging amendments to exclude legacy trades. Given the need for global consistency, their advocacy is likely to succeed. However, the clock is ticking, this year’s AANA calculations in the affected jurisdictions will take effect from 1 September 2024, clarity will be required well in advance.
[1] §ll.1 Authority, purpose, scope, exemptions and compliance dates. .1(g)(2) If a covered swap entity’s counterparty changes its status such that a non-cleared swap or non-cleared security-based swap with that counterparty becomes subject to less strict margin requirements under this [part] (such as if the counterparty’s status changes from a financial end user with material swaps exposure to a financial end user without material swaps exposure), then the covered swap entity may comply with the less strict margin requirements for any noncleared swap or non-cleared security based swap entered into with that counterparty after the counterparty changes its status as well as for any outstanding non-cleared swap or noncleared security-based swap entered into after the applicable compliance date in paragraph (e) of this section and before the counterparty changed its status.
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