Three US banking regulators determined that banks could avoid severe capital charges when entering into cleared derivatives transactions by treating variation margin payments as settlement payments as opposed to collateral payments, provided exchange rules authorized such treatment. Such rules would enable banks to regard each derivatives contract as having no outstanding exposure on a cleared contract after a variation margin payment is made, until the next exchange of variation margin (i.e., the next business day). This substantially reduces a bank’s theoretical future exposure on the contract, reducing its capital charges (the measure of future exposure is dependent on the type of contract and its remaining maturity). The three banking regulators making this determination were the Office of the Comptroller of the Currency, the Board of Governors of the Federal Reserve System and the Federal Deposit Insurance Corporation. Surprisingly, Thomas M. Hoenig, FDIC Vice Chairman, issued a statement criticizing this determination claiming, “The guidance effectively lowers the amount of capital required for certain derivatives contracts although the underlying economics of the transactions do not change.” (Click here to access Mr. Hoenig’s statement.)