Derivatives: ISDA Announces 2016 New York Law Variation Margin Credit Support Annex

by Liskow & Lewis

On April 14, 2016, the International Swaps and Derivatives Association, Inc. (ISDA) announced the 2016 ISDA Credit Support Annex for Variation Margin for use with New York law transactions (the 2016 CSA).

ISDA is in the process of updating certain of its documents to account for recent regulatory reforms.  The 2016 CSA introduces updates to the existing 1994 ISDA Credit Support Annex (the 1994 CSA) that will facilitate compliance with margining requirements for non-centrally cleared derivatives.  Parties to the 2016 CSA are able to negotiate collateral terms for variation margin in accordance with rules issued by U.S. prudential banking regulators[1], the U.S. Commodity Futures Trading Commission (the CFTC), and the European Union.

The fallout from the most recent financial crisis demonstrated a number of weaknesses in the OTC derivatives market.  In response, the G20 countries have been pursuing reforms to mitigate systemic risk posed by global OTC derivatives practices.  In 2011, the G20 countries requested that the Basel Committee on Banking Supervision and the International Organization of Securities Commissions (BCBS/IOSCO) jointly prepare minimum standards for margining requirements that would apply to non-centrally cleared derivatives.  BCBS/IOSCO published a final policy framework in 2015 (the BCBS/IOSCO Framework) requiring that market participants mitigate risk in OTC transactions by exchanging initial margin and variation margin.[2]  The statements of the BCBS/IOSCO Framework were not meant to be binding regulations, but rather key principles to guide national regulators in adopting margining rules that would apply in their respective jurisdictions.  Regulators in several jurisdictions, including the United States and the European Union, have since published margining rules for non-centrally cleared derivatives.[3]

Generally, the U.S. and EU rules require the collection or posting of initial margin and variation margin effective as of September 1, 2016 for the largest participants in the derivatives market.  Initial margin requirements for other market participants will be phased in over a four-year period while variation margin requirements for other market participants take effect as of March 1, 2017.  These regulatory initiatives dictated that the existing ISDA collateral documentation be revised.

For over 20 years, the existing 1994 CSA has been the preferred instrument for detailing credit support arrangements related to New York law ISDA contracts.  The 2016 CSA is the first attempt to update the credit support documentation and it contains notable revisions from the 1994 CSA.  While the 1994 CSA was intended to document both variation margin and initial margin requirements, the new 2016 CSA is intended to document only variation margin requirements.  Initial margin requirements are excluded from the 2016 CSA and, if applicable, would be addressed in a separate instrument.  Accordingly, the 2016 CSA provisions have been uniformly revised to account for only variation margin matters.  Other key revisions to the 2016 CSA include the following:

  • the scope is limited to “covered” transactions that are relevant for determining exposure under applicable rules;
  • the concept of a threshold for uncollateralized exposure is no longer relevant;
  • the timing for transfers of collateral delivery amounts has been shortened by one business day (timely demands require same day transfers);
  • the collateral eligibility standards incorporate regulatory compliance requirements;
  • collateral valuations include options for additional haircuts;
  • the dispute resolution procedures and exposure determinations account for a close-out amount structure under the 2002 ISDA Master Agreement;
  • the interest provisions include elections relating to interest payment mechanics and netting;
  • the interest provisions contemplate negative interest situations;
  • past due interest transfer payments incur default interest;
  • an obligation to transfer credit support under the 2016 CSA may be offset against an obligation to transfer credit support under other credit support annexes; and
  • the default remedies permit posted collateral held under the 2016 CSA to be offset against certain credit support under other credit support annexes.

Similar to the 1994 CSA, the 2016 CSA is an optional, bilateral form that contemplates both parties may be required to post credit support.  It consists of a pre-printed Annex which can be modified in a separately negotiated Paragraph 13.  And consistent with ISDA’s overall documentation architecture the 2016 CSA is a supplement to the Schedule to the ISDA Master Agreement for use with New York law transactions.  The 2016 CSA is available here.

ISDA is preparing an English law version of the credit support annex for variation margin, stand-alone credit support annexes for initial margin under New York and English law, and one or more protocols to amend existing contracts to comply with margining rules.  ISDA is also involved in recommending a singular methodology for calculating initial margin on non-centrally cleared derivatives called the Standard Initial Margin Model (SIMM).

[1] The U.S. prudential banking regulators are the Federal Deposit Insurance Corporation (FDIC), the Office of the Comptroller of the Currency, the Board of Governors of the Federal Reserve System, the Farm Credit Administration, and the Federal Housing Finance Agency.

[2] Click here to access the BCBS/IOSCO final framework entitled “Margin Requirements for Non-Centrally Cleared Derivatives” which was originally published in September 2013 and re-published in March 2015.  BCBS/IOSCO published the framework in consultation with the Working Group on Margining Requirements (WGMR) which was established in 2011 to develop a consistent global standard for margining requirements.  The WGMR is a collective effort by the Committee on Payment and Settlement Systems and the Committee on the Global Financial Systems.

[3] The U.S. prudential banking regulators issued final margining rules for non-centrally cleared derivatives in October 2015, click here to access the rules.  The CFTC issued final rules in December 2015, click here to access the rules.  The prudential regulators and CFTC have included margining exemptions for non-centrally cleared derivatives executed with counterparties that are exempt from Dodd-Frank’s mandatory clearing requirements.  In the coming months, the U.S. Securities and Exchange Commission will issue a separate set of final rules for entities subject to its jurisdiction.  In March 2016, EU regulators published final draft regulatory technical standards (RTS) for the collateralization of non-centrally cleared derivatives under the European Market Infrastructure Regulation (EMIR), click here to access the rules.  The final draft RTS have been submitted to the European Commission for approval.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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