Introduction

The Financial Supervisory Service (FSS) of Korea published the draft ‘Guidelines on Margin Requirements for Non-Centrally Cleared OTC Derivatives Transactions’1) (Guidelines) on 14 December 2016 and invited comments to be submitted by 2 January 2017. This forms part of global efforts to reduce systemic risk relating to OTC derivatives transactions and is aimed at implementing the ‘Margin Requirements for Non-Centrally Cleared Derivatives’ (Recommendations) published in March 2015.

The Recommendations and, by extension, the Guidelines, seek to reduce systemic risks inherent in OTC derivatives which are not centrally cleared through a central counterparty (CCP) by requiring all financial institutions and systemically important non-financial institutions to receive and deliver additional margin in respect of outstanding OTC derivatives transactions which are not cleared through a CCP.

Main Provisions

A. Products

The Guideline applies to all OTC derivatives transactions which are not cleared through a CCP. FX forward and swap and currency swap which are physically settled are excluded.

B. Institutions 

Financial institutions such as bank, financial investment company, insurance company, etc. and on/off-shore collective investment schemes trading OTC derivatives shall be obliged to comply with the Guidelines. Non-financial company corporations, the Bank of Korea, public institutions, international institutions such as BIS, etc. are excluded from the scope.

C. Phase-in Timetable

1. Initial Margin

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2. Variation Margin

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“Aggregate Outstanding Transactions” is the simple average of yearly second quarter month-end notional amounts aggregating all outstanding amounts of the financial group.

Exchange of initial margin shall apply to new contracts executed after each relevant application date.

* For variation margin only, the relevant institutions shall be allowed 3 months from each Implementation Dates to prepare for implementation.

D. Eligible Collateral/Haircut

Cash, gold, government bonds, foreign government bonds, high quality corporate bonds, listed shares shall be eligible collateral. Shares issued by a party itself will not be treated as eligible collateral. Haircut rates have been published but the Guidelines also allow for parties to use its internal standards as long as consistent rates are applied for each type of eligible collateral.

E. Margin Calculation etc.

1. Margin Calculation 

(i) Initial margins can be calculated by either the ‘standard initial margin calculation model’ or a quantitative portfolio model developed autonomously by a party. The two models cannot be used as alternatives depending on which is more favourable under the circumstances but a party must elect one and use it consistently. An entity wishing to use its internal quantitative model approved by a foreign supervisor must report the quantitative model name and the fact of approval to the FSS.

(ii) Variation margin must be calculated in a consistent way in relation to a counterparty and reflect the current exposure related to the portfolio and may either be directly calculated by an entity’s internal model or outsourced to a third party. Daily margin calculation is recommended to efficiently manage exposure for market fluctuations.

2. Threshold and Minimum Transfer Amount (MTA) 

(i) Initial Margin

- Threshold: not greater than KRW 65 billion

-MTA: not greater than KRW 1 billion

Threshold is to be applied to the entire financial group but distribution of threshold by each entity within a financial group and by product may be determined through mutual agreement. MTA must be applied for each counterparty, and if margin to be exchanged is above MTA, the whole margin must be exchanged without deducting the MTA.

(ii) Variation Margin

-Threshold: zero

-MTA: not greater than KRW 1 billion

3. Exchange

Initial margin shall be exchanged on a gross basis whereas variation margin shall be exchanged on a net basis.

F. Others

1. Intra-Group margining 

Margin must be exchanged based on the Guidelines for transactions within a financial group. However, the Guidelines will not apply to a financial institution which has in place the system to integrally manage risks of the financial group.

2. Subsituted Compliance

Substituted compliance will be permitted for transaction between ‘foreign established financial institutions’ which comprise of (i) foreign financial institutions established outside Korea, (ii) Korean branches of foreign financial institutions, and (iii) subsidiaries of Korean financial institutions established outside Korea. This is conditional on the FSS recognizing the equivalence between the Guidelines and the margin rules of the relevant foreign supervisory bodies.

3. Dispute Mediation 

The entity will need to agree with its counterparty detailed procedures to detect, record and monitor disputes concerning confirmation, valuation and exchange of margin for OTC transactions. In addition, it must prepare dispute resolution procedures.

Consultation Process 

The FSS has invited interested parties to provide comments and feedback on the Guidelines by close of business on 2 January 2017. Please feel free to contact us if there is anything that you wish to discuss with us or want us to assist in preparing a submission to the FSS.