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Non-cleared Derivatives Margin Rules could force re-think of SCSA

Here is a link to an interesting article in Risk Magazine regarding the potential impact of the “near final” BCBS/IOSCO margin rules for non-cleared derivatives (the “BCBS/IOSCO Rules”) on the adoption of ISDA’s standard credit support annex (SCSA).

The BCBS/IOSCO consultation paper which includes the “near final” rules was published on 15 February 2013 (see this blog post for more detail).   Among other things, the BCBS/IOSCO Rules require the application of haircuts (either model-based on standardised) to eligible collateral.  Whilst eligible collateral can be denominated in any currency an additional haircut of 8% is applied in the event that the currency of the underlying obligation differs from the currency of the associated collateral.  Whilst this will cause issues for users of the traditional CSA, it is likely to be particularly problematic for users of the new SCSA.

Under the SCSA, transactions are allocated to one of 17 currency ‘silos’ and cash collateral in that currency must be posted in relation to all transactions within the silo.  Whilst this mirrors the methodology applied by Swapclear and therefore reduces possible issues as trades transition between a non-cleared and a cleared environment, it creates a significant degree of cross-currency settlement risk (known as “Herstatt risk”) in the process.  In order to mitigate the Herstatt risk, ISDA developed its “implied swap adjustment” (“ISA”) methodology under which counterparties could net the various collateral flows associated with the 17 currency silos into a single payment in one “transport currency” (being AUD, CAD, EUR, GBP, CHF, USD or JPY).  Unfortunately, therefore, as the currency of the collateral transferred between counterparties will be different to the currency of many of the underlying transactions, the mitigation of Herstatt risk has the unintended consequence of amplifying the effect of the 8% haircut, with the result that a number of dealers are now questioning whether the SCSA can be adopted at all.

It is still slightly unclear whether, in spirit, the BCBS/IOSCO Rules are meant to apply in these circumstances and there is still slight hope that they may be amended such that the 8% haircut will not apply if either the currency of the collateral is the same, or is computed in a way that is “economically the same”, as that of the underlying transaction.  The consultation period for the BCBS/IOSCO Rules closed on 15 March 2013.  ISDA is currently awaiting the publication of the final rules before deciding whether and how the SCSA should be amended, so watch this space.

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