On December 18, 2017, the European Supervisory Authorities (ESAs) published a final report aiming to align the treatment of variation margin for physically settled foreign exchange forward transactions (FX Forwards) with supervisory guidance applicable in other key jurisdictions.

The amended draft variation margin regulatory technical standards on risk mitigation techniques for over-the-counter (OTC) derivatives not cleared by a central counterparty (Draft RTS) limit the requirement to collect variation margin for FX Forwards to only transactions concluded between “institutions,” defined by the ESAs as credit institutions and investment firms, or with an equivalent entity located in a third country that would meet the definition of “institution” if located in the European Union (EU). The ESAs are of the view that, for institution-to-non-institution transactions, the competent authorities should apply the EU’s variation margin rules (VM Rules) in a risk-based and proportionate manner until the amended Draft RTS go into effect, which would be some time after January 3 (scheduled date).

As previously noted in the Corporate & Financial Weekly Digest edition of December 1, 2017, FX Forwards were scheduled on the scheduled date to become subject to the variation margin requirements set out in Commission Delegated Regulation (EU) 2016/2251 of October 4, 2016 (EU Margin Regulation) that apply generally to OTC derivatives.

On November 24, 2017, the ESAs cast the scope of FX Forwards variation margin obligations into some doubt when they announced an urgent review of whether the Draft RTS should apply to all counterparties entering into FX Forwards from the scheduled date. The ESAs intended to propose amendments to the Draft RTS to harmonize the EU’s VM Rules under the European Market Infrastructure Regulation (EMIR) for FX Forwards with equivalent rules in other jurisdictions. The ESAs stated a review was necessary because, although the VM Rules form part of a globally agreed framework, some jurisdictions have a lower scope of application and generally exempt all end-user counterparties from FX Forward variation margin requirements.

The ESAs’ final report, containing the amended Draft RTS, suggested that the implementation of the new VM Rules “should not tilt towards further exemption, especially as most parts of the framework have been successfully implemented.” However, the ESAs also acknowledged that “the regulatory framework implemented in non-EU jurisdictions may put EU counterparties at a disadvantage,” especially if there are EU institutions trading with non-EU counterparties.

The ESAs have therefore proposed in their final report an amendment under Article 31a of the amended draft RTS, to the effect that EU counterparties should not be disadvantaged by the lack of implementation of the VM Rules in other key jurisdictions.

The ESAs’ final report containing the amended Draft RTS is available here.