UK offers six-month margin reprieve for China netting sweep

Transition period falls short of Isda’s 18-month request, Hong Kong mulls similar relief

China deadline

UK regulators are consulting on proposals that would give Chinese counterparties an additional six months to comply with non-cleared margin rules when the country’s close-out netting opinion is finalised later this year, causing an existing exemption to evaporate.

While the consultation – published by the Prudential Regulation Authority and Financial Conduct Authority – has been welcomed, the relief falls short of an 18-month grace period requested by the International Swaps and Derivatives Association. Participants also warn that regulators in Europe and Asia would be required to take similar action to avert widespread chaos.

“The UK has been first out of the gate showing the direction of travel, which is hugely positive, as it’s an acknowledgement that we must have this transitional relief,” says a lawyer at one global bank.

“It’s now a case of looking at the consultation and the comments. I expect one of the comments that will go back on this consultation is the emphasis on timing. Six months, when you have a situation like China, doesn’t feel long enough at all.”

Non-cleared margin rules penned in Europe and Asia provide an exemption for firms in non-nettable jurisdictions. This means entities that breach thresholds for aggregate average notional amounts of bilateral derivatives are not currently required to charge regulatory initial margin on bilateral trades.

In China, these exemptions are set to fall away, since derivatives laws passed in April paved the way for recognition of close-out netting in the country. Law firm King & Wood Mallesons is set to publish a netting opinion on behalf of Isda in August.

This would bring a slew of Chinese firms immediately into scope on September 1, when the sixth and final phase of IM rules catches an additional 800 entities.

Isda recently called on global regulators to provide a transition period of a year-and-a-half for these entities to avert widespread trading halts, as in-scope firms scramble to complete cumbersome account setups.

“We welcome the intent behind the proposed transition, and are reflecting on whether the practical application of this period will be long enough where infrastructure in a jurisdiction is not well developed,” says Tara Kruse, global head of infrastructure, data and non-cleared margin at Isda.

“It’s important that firms have sufficient time to prepare for implementation of initial margin requirements in situations when compliance by a certain class of counterparty or across a particular jurisdiction is suddenly required,” she adds.

A spokesperson for the Hong Kong Monetary Authority (HKMA) says the regulator will shortly announce its own plans: “In the context of the Chinese Futures and Derivatives Law, the HKMA is looking into the possibility of a specifically defined additional relief period and plans to update the industry on this in the near future.”

The spokesperson adds that broad respite already exists in article CR-G-14 of the supervisory policy manual, which states that margin should be exchanged by covered entities “as soon as practicable” in cases where exemptions no longer apply.

A European Securities and Markets Authority spokesperson declined to comment on whether plans were afoot in the European Union, while a European Banking Authority spokesperson did not respond to a request for comment.

The issue is not applicable in the US, where there is no specific carve-out for non-nettable regimes.

Action-heavy process

Initial margin preparations typically take six to 12 months, according to Isda estimates, requiring custody accounts to be opened, new credit support annexes to be negotiated and eligible collateral schedules to be agreed between counterparties.

“A six-month period when you’re looking at the China situation feels relatively short, given all the actions firms would put in place, particularly given the lack of familiarity with margin rules it is expected Chinese counterparties will have,” says the bank lawyer. The lawyer adds that changes in netting status of a previously exempt jurisdiction could require a significant education effort across hundreds of counterparties, while rules may also need to be translated into local language.

Affected firms would typically have longer than the proposed six months to prepare following the Isda netting determination. Individual banks typically conduct their own independent legal reviews before deeming a jurisdiction to be nettable, potentially stretching the timeline by weeks or months for some counterparties.

The Hong Kong Monetary Authority is set to announce its own plans

While the period of relief falls short of industry hopes, the UK proposals apply to more general transition scenarios, where a counterparty might suddenly become subject to the rules. This could include a change in the classification status of a specific entity, for example a non-financial counterparty suddenly breaching the threshold as a result of corporate restructuring.

Crucially, this transition period would not apply in more general scenarios, for example in-scope firms relying on a €50 million exchange threshold, under which they are not required to exchange margin.

“For the avoidance of doubt, this proposal does not change timelines for the phase 6 implementation of margin requirements in September 2022,” say the regulators in the UK consultation.

The UK regulators also propose widening the pool of funds that can be accepted as collateral, addressing a longstanding bugbear in the UK regime. Currently, UK regulated entities may only post UK registered Ucits funds as regulatory IM. Yet a dearth of UK-registered Ucits has rankled participants.

The regulators propose a new set of principles allowing firms to post third-country money market funds as collateral, providing they meet certain criteria.

“Where firms accept third-country funds as collateral, the PRA and FCA would expect firms to be able to demonstrate they have completed the risk assessment. This assessment would confirm that a jurisdiction’s legal framework for the relevant funds provides comparable risk management protections to those applied to UK Ucits,” say the regulators.

The consultation is set to close on October 12.

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