Navigating the New Margin Requirements HKMA CR-G-14

Transcription

1 Navigating the New Margin Requirements HKMA CR-G-14 Managing Risk while Maximizing Liquidity in the OTC Non-Centrally Cleared Derivatives Market August 2017

2 Hong Kong Monetary Authority (HKMA) Supervisory Policy Manual (SPM) CR-G-14: Non-centrally Cleared OTC Derivatives Transactions Margin and Other Risk Mitigation Standards Overview Sets out the minimum standards that the HKMA expects Authorized Institutions (AIs) to adopt in respect of margin and other risk mitigation standards for non-centrally cleared OTC derivatives transactions. Variation Margin (VM) requirements at zero threshold for all covered entities will start from 1 March 2017 (subject to a 6-month transition period) and exchange of Initial Margin (IM) will commence on 1 September 2017 determined by a phase-in schedule through 2020 Based on the BCBS/IOSCO framework 1 both IM and VM requirements have been proposed or adopted in Canada, the European Union, Japan, Switzerland, the United States, Australia, Hong Kong, Singapore, and Korea (it is expected that other jurisdictions will propose and adopt similar requirements to encourage standardization for OTC derivatives) Risk Mitigation Standards (RMS) are qualitative standards used to promote legal certainty for OTC derivative transactions, foster effective management of counterparty credit risk, improve efficiency and facilitate timely resolution of disputes. HKMA expects AIs to apply RMS in a proportionate manner depending on the level of risk concentration or activity undertaken by an AI, which will take into account the nature of the transactions and counterparty. Application Timeline 1 March 2017 VM VM will need to be exchanged for all relevant non-centrally cleared derivatives entered into with a covered entity (subject to an initial 6-month transition period provided until 31 August 2017). Counterparties are actively assessing current trading relationships to determine whether VM requirements can be achieved or new swap transactions will be prohibited. IM phase-in schedule based on respective HKD threshold RMS phase-in schedule based on respective HKD threshold (RMS zero threshold on a permanent basis from 1 September 2021 for each subsequent 12-month period) 1 2

3 Requirement Details Understanding each component in CR-G-14, identifying the specific impacts across your organization, and structuring a future-state solution to address the interlinked requirements across various departments can be a puzzle. Dispute Risk-Based Supervisory Minimum Transfer Amounts Back-Testing Annual Validation Concentration Limits Potential Areas of Impact Treatment of Collateral Eligible Assets Model Approval Internal Audit Segregated Accounts Derivative Funding Liquidity and Capital Requirements Data Repositories Haircuts Tracking and Reporting AANA Threshold Calculation Netting Sets Collateral Management Operations Risk Mitigation Procedures Reconciliation Valuation Trading Relationship Documentation Trade Compression Substituted Compliance Regulatory Reporting and Disclosures CR-G-14 and the shared principles from global margin regulation (BCBS/IOSCO) will have liquidity and capital implications, and a direct impact on risk mitigation policies and collateral processing operations. Firms will need real-time collateral data across business lines and global repositories to actively manage valuation and substitutions of collateral with each transaction. Segregation Counterparty Management Management of collateral demands due to reduced collateral velocity resulting from limited/no rehypothecation Selection of segregation model to meet jurisdictional requirements Execution of Account Control Agreements with custodians providing segregation services Development of standard industry messaging protocols for collateral movement Daily monitoring of bilateral risk and reconciliation of collateral balances Operations Entity level disclosure via ISDA amend for jurisdiction, Av. Net Notional Amount (ANNA), etc. Support for multiple agreement frameworks (legacy and reg. CSAs) that include settlement provisions Dynamic allocation of group level threshold for reg IM Issuance of standardized margin call statement Collateral Eligibility Management of differences in collateral eligibility across jurisdictions; US only allows cash for VM Computation of concentration risk and Wrong Way Risk for EU Management of jurisdiction specific approaches to haircuts: US proposes only scheduled based haircuts, model based haircuts in EU Interpretation of Transfer Currency for VM and Termination Currency for IM IM and VM Calc. Computation of risk sensitivities at trade level Application of 8% currency haircut for IM and/or VM (based on jurisdiction) not aligned with underlying currency; reduced/no netting VM processing for dealer non-dealer transactions Management of IM Disputes Trade Execution Capture of counterparty information including covered entities, jurisdiction, etc. Alignment of trade currency buckets with CSAs for VM calculation Routing of trading/collateral calculations to risk applications (Basel III, RWA, Valuations) 3

4 Risk Mitigation Standards (RMS) Scope of Application (If any of the following activities are performed by a third-party, then an AI will need to follow the guidance set out in SPM SA-2 Outsourcing in relation to third-party service providers) Trading Relationship Documentation Provide legal certainty, include material rights and obligations of counterparties, provide consistency with applicable law or regulation Payment obligations Calculation and Netting arrangements Default or termination events Transfer rights and obligations Governing law Valuation, Reconciliation, Dispute Credit Support Annex Trade Confirmation One-way or Two-way confirmation completed as soon practicable, maintain records of unconfirmed transactions after 5 business day from execution Interest Rate Swaps, Cross-Currency Swaps, Credit Default Swaps T+1 from and after 1 March 2017 All other product types T+2 from 1 September 2017 to 28 February 2018 T+1 from and after 1 March 2018 Valuation with Counterparty Determinations should be based on economically similar transactions Documentation should include an alternative process or approach to determine the value in the event of unavailable or failure of any required inputs To address valuation uncertainty, agreement with counterparty on a rigorous and robust dispute resolution procedures before the executing a transaction Reconciliation Greater than 10% difference between the lower valuation and higher valuation will need to be reconciled. Reconciliation should encompass all outstanding transactions with Financial and Significant Non-Financial counterparties (CPs) Daily recon for CPs with +500 Weekly recon for CPs with 51 to 499 Quarterly recon for CPs with 50 or less Quarterly for all other counterparties with +100 outstanding transactions and annually for less than 100 outstanding transactions Compression Implement policies and procedures to regularly assess and perform portfolio compression on a bilateral or multilateral basis to replace economically-equivalent transactions by decreasing number of transactions and/or total notional value VM and IM need not be exchanged in respect of new contracts ( replacement trades ) resulting from portfolio compression that is performed exclusively on legacy contracts VM and IM provisions will apply to replacement trades resulting from any such exercise on portfolios comprising legacy and new trades Dispute AIs will need to agree and document with each CP a mechanism or process to determine when material discrepancies should be considered a dispute, and how they should be resolved as soon as practicable. Material disputes greater than HKD 100M (or its currency equivalent) will need to be reported to HKMA if not resolved in 15 business days. Detailed procedures for dispute identification, recording, and monitoring should be maintained. Recommended areas of focus include: Reconciliation, Compression, Dispute Market participants have embraced industry Utilities and Vendor solutions to meet these requirements 4

5 Next Steps for CR-G-14 Compliance A fundamental assessment for margin processing will include review of Documentation, Calculation, Dispute, and Segregation procedures. Determination for applicable jurisdictions and the corresponding margin requirements will need to be assessed with each counterparty. Gap Analysis and Target Operating Model Design ISDA CSA, CSD, and ACA Negotiations STP Connectivity with Collateral Management Systems Vendor, Outsourcer, and Utility Selection Credit Support Annex (English Law) (Japanese Law) ISDA 2016 Credit Support Annex for Initial Margin ISDA 2016 Credit Support Deed for Initial Margin (English Law) ISDA 2016 Credit Support Annex for Initial Margin (Japanese Law and Trust Scheme Addendum) Central Securities Depository and Custodial Agreements ISDA Euroclear Collateral Transfer Agreement ISDA Euroclear Collateral Transfer Agreement (Multi-Regime English Law) ISDA Euroclear Security Agreement (Belgian Law) ISDA Clearstream Collateral Transfer Agreement (Multi-Regime English Law) ISDA Clearstream Security Agreement (Luxemburg Law) Amendment Provisions with respect to Japanese Securities Account Control Agreement (New York Law or English Law) Subject Matter Experts Contact our Subject Matter Experts to support your efforts in developing an end-to-end solution for your liquidity and collateral management requirements. Albert Lo Partner albert.kh.lo@hk.pwc.com Tasos Zavitsanakis Director tasos.zavitsanakis@ hk.pwc.com Jeff Lee Manager jeff.cy.lee@hk.pwc.com Philip Chan Manager philip.mk.chan@ hk.pwc.com This content is for general information only, and should not be used as a substitute for consultation with advisors PricewaterhouseCoopers Consulting Hong Kong Limited. All rights reserved. PwC refers to the Hong Kong member firm, and may sometimes refer to the PwC network. Each member firm is a separate legal entity. Please see for further details. HK C1