Corporate & Securities Singapore Client Alert October 2015 Consultation on Margin Requirements for NonCentrally Cleared Derivatives On 1 October 2015, the Monetary Authority of Singapore ("the MAS") issued a Consultation Paper on Margin Requirements for Non-Centrally Cleared Derivatives (the "Consultation Paper"). This seeks to address the risks from uncleared derivatives, following the MAS' Consultation Paper on Draft Regulations for Mandatory Clearing of Derivatives on 1 July 2015 which proposes regulations for mandatory clearing of specific classes of derivatives. For further information on this, please see our earlier update here. We outline in the table below some key proposals in the Consultation Paper. The MAS is inviting comments and views by 1 November 2015. If you have any comments, please contact us. Please see this link for further details on the proposals: Consultation Paper. Scope of Proposed Margin Requirements 1. Products Covered. The margin requirements would apply to all OTC derivative contracts which are not centrally cleared by a qualifying central counterparty. Physically-settled foreign-exchange ("FX") forwards and swaps shall be exempted, although entities are expected to appropriately manage the risks associated with such FX transactions. 2. Entities Covered. The MAS proposes a phase-in approach. For a start, the margin requirements will only apply to entities conducting regulated activities under the Securities and Futures Act ("SFA"), including banks licensed under the Banking Act, merchant banks licensed under the MAS Act, financial institutions licensed under the Finance Companies Act, Insurance Act, SFA and Trust Companies Act ("MAS Covered Entities"). Fund managers shall be subject to the proposed margin requirements if they are legal counterparties to the transaction. Exemptions. The following exemptions are proposed: a. For certain licensed financial institutions, including those licensed under the SFA (but not banks and merchant banks), where the exposure of uncleared derivative transactions booked in Singapore falls below a certain threshold. b. Counterparties such as sovereigns, central banks, public sector entities, multilateral development banks and the Bank for International Settlement. c. Intra-group transactions, subject to the condition that the MAS Covered Entity comes under group-wide supervision by MAS or regulators in other jurisdictions and provided that they have group consolidated financial statements. The MAS is considering including investment funds domiciled in Singapore to comply with the proposed margin requirements if these funds have exposure in uncleared derivatives to the excess of the exemption threshold above. For the purposes of calculating this threshold, an investment fund would be treated as distinct and separate only if the fund has a distinct segregated pool of assets for the purposes of fund insolvency or bankruptcy; and is not collateralised or guaranteed by any other person. The MAS is seeking feedback on this and how to calculate the above thresholds, among others. For further information please contact Stephanie Magnus +65 6434 2672 firstname.lastname@example.org Liew Ying Yi +65 6434 2531 YingYi.Liew@bakermckenzie.com Baker & McKenzie.Wong & Leow 8 Marina Boulevard #05-01 Marina Bay Financial Centre Tower 1 Singapore 018981 www.bakermckenzie.com Regulatory / Compliance Firm of the Year (Singapore) 2010 - 2014 Asian-MENA Counsel 2 Client Alert October 2015 Scope of Proposed Margin Requirements Deemed compliance for cross-border transactions. The MAS proposes to deem MAS Covered Entities as having complied with the margin rules when: a. an MAS Covered Entity, established under the laws of, or that has a place of business in, a foreign jurisdiction with comparable margin requirements, is required to comply and has complied with the margin requirements of that relevant foreign jurisdiction; and b. an MAS Covered Entity, trading with a foreign counterparty, is required to comply with and has complied with comparable home- or hostmargin requirements imposed on the foreign counterparty. There are no details on the comparable jurisdictions yet but the MAS proposes a comparability assessment that is outcome-based. However, residual requirements in relation to the collateral may still be imposed. 3. When it Applies. A MAS Covered Entity will be subject to the initial margin ("IM") and variation margin ("VM") requirements where all the following conditions are met: a. The MAS Covered Entity is a legal counterparty to the transaction (meaning that it was the signatory of the ISDA master agreement and collateral service agreement of the transaction); b. The transaction is booked in Singapore; and c. The transaction is entered into with a counterparty which is either: (i) an MAS Covered Entity; or (ii) an overseas regulated financial firm. 4. Margin Requirements. The proposed requirements are as follows: a. All MAS Covered Entities are to calculate their VM obligations on a daily basis. b. The full amount of VM (i.e. a zero threshold) must be exchanged (if MAS adopts a post-and-collect regime) or collected (if MAS adopts a collect-only regime) from counterparties within 2 business days following the execution of a new uncleared derivative contract. (The MAS is considering imposing a collect-only requirement rather than a post-and-collect regime and is inviting feedback on the pros and cons of each). c. All MAS Covered Entities are to calculate the gross amount of IM obligations (i.e. no netting of IM payments between the two counterparties) at least on a sufficiently regular basis to reflect changes in risk positions and market conditions. d. IM is to be exchanged or collected from counterparties within 2 business days following the recalculation of the IM obligations. e. Exchange or collection of IM shall only be required if the cumulative IM exposure from the counterparty exceeds S$80 million. The S$80 million is to be calculated at the group-consolidated level and is based on all uncleared derivatives between the two consolidated groups. f. All margin transfers will be subject to a minimum transfer amount, which shall not be higher than S$800,000. As a start, the IM requirements would only apply to transactions between two entities, each belonging to a group whose aggregate gross notional uncleared derivatives exposure (including physically-settled FX forwards and swaps) exceeds the applicable IM phase-in thresholds (see Phase-in Implementation table below). At the end of the phase-in period, the minimum level of uncleared derivative activity for the IM requirements to apply shall be S$13 billion. 5. Margin Calculations and Methodologies. Some proposals in relation to the calculation of IM are as follows: a. IM shall be exchanged or collected at the outset of a transaction, and exchanged or collected thereafter on a routine and consistent basis upon changes in the calculated potential future exposures. b. At a minimum, IM shall be recalculated and exchanged or collected in any of the following circumstances: a new contract is executed with a counterparty; an existing contract with a counterparty expires; the IM model is recalibrated due to changes in market conditions; or no IM recalculation has been performed in the last 10 days. c. MAS proposes to allow the required amount of IM to be calculated by 3 Client Alert October 2015 Scope of Proposed Margin Requirements reference to either: (i) a quantitative portfolio margin model; or (ii) a standardised margin schedule. An MAS Covered Entity may opt for either approach, and not restrict itself to one approach for the entirety of its derivative activities. For VM, a. MAS Covered Entities must post or collect the full amount of VM necessary to fully collateralise the mark-to-market exposure of the uncleared derivatives b. MAS Covered Entities shall calculate and post or collect VM requirements on an aggregate net basis across all uncleared derivatives that are executed under a single, legally enforceable netting agreement. c. In the absence of legally enforceable netting agreements, MAS Covered Entities should calculate and post or collect the VM requirements for each uncleared derivative contract on a gross basis. MAS Covered Entities must have rigorous and robust dispute resolution procedures in place with their counterparties and agree to the specified margin calculation method before the onset of a transaction. In the event that a margin dispute arises, the non-disputed amount shall first be posted or collected, while all necessary and appropriate efforts, including timely initiation of dispute resolution protocols, should be taken to resolve the dispute and post or collect the remaining required amount of margin in a timely fashion. 6. Eligible Collateral, Haircuts and Treatment of Collateral. The MAS proposes to prescribe the range of eligible collateral, align the standardized schedulebased haircuts for permitted eligible collateral for IM and VM to the standard supervisory haircuts imposed for eligible financial collateral recognized under the MAS' capital framework for locally incorporated banks. The MAS also proposes to impose requirements on the safekeeping of IM collateral and to require all collateral arrangements to be reviewed periodically with updated legal opinions to ensure that the arrangements continue to be legally enforceable. Further, non-cash IM shall only be rehypothecated to a third party in accordance with a prescribed list of conditions. Such rehypothecation can only happen once. The MAS has proposed the following phase-in implementation schedule: Obligation MAS Covered Entity Belonging to Group Exceeding Phase-in Threshold Commencem ent Date Variation Margin (VM) Banks licensed under the Banking Act and conducting regulated activity under the SFA ("Commercial Banks") S$4.8 trillion 1 Sept 2016 All other Commercial Banks and merchant banks approved under the MAS Act - 1 Mar 2017 Initial Margin (IM) Commercial Banks S$4.8 trillion 1 Sept 2016 All other Commercial Banks and approved merchant banks S$4.8 trillion 1 Mar 2017 S$3.6 trillion 1 Sept 2017 S$2.4 trillion 1 Sept 2018 S$1.2 trillion 1 Sept 2019 S$13 billion 1 Sept 2020 ©2015 Baker & McKenzie. All rights reserved. Baker & McKenzie.Wong & Leow is a member of Baker & McKenzie International, a Swiss Verein with member law firms around the world. 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