Three federal banking regulatory organizations finalized a rule to recognize the mitigating impact of margin in calculating counterparty credit risk for derivatives. The three organizations are the Federal Deposit Insurance Corporation, the Federal Reserve Board and the Office of the Comptroller of the Currency.
Under the rule, banks may recognize client initial margin as an offset in assessing their exposure to derivatives contracts in calculating their supplementary leverage ratio. Applying this ratio, some of the largest US banks are required to set aside as much as 5 percent of their assets as a guard against losses. Currently, these assets include cash posted as initial margin by customers for their swaps and other derivatives trading activity through the banks’ futures commission merchant subsidiaries.
Additionally, the rule ameliorates the measure of risk of doing business with commercial end-users that are entering into derivatives contracts to hedge or mitigate their risks. The rule accomplishes this by eliminating a heightened or “alpha factor” of 1.4 for assessing counterparty credit risk for derivatives contracts with qualified commercial counterparties (the banking organizations term the alpha factor “a measure of conservatism”). According to Walk Lukken, President of FIA, “[t]his [new rule] will preserve access to derivatives for manufacturers, transportation companies and other commercial enterprises that use derivatives to hedge price risk.” (Click here for the full FIA statement in response to the new rule.) However, the Coalition for Derivatives End-Users expressed concern that the final rule implementing the standardized approach for calculating the exposure amount of derivatives contracts – known as SA-CCR – does not go far enough in helping end-users as the collateral recognition benefit only applies to cash collateral; according to the Coalition, most end-users do not post cash but use alternative forms of margining (e.g., liens and letters of credit; click here for details).