An update on the new EU margin rules and the ISDA 2016 Variation Margin Protocol

In brief...

New EU margin rules are now final, subject to ratification. They are part of a global initiative regulating the posting of initial and variation margin when trading non-cleared OTC derivatives. 1 March 2017 is the key implementation date for variation margin (with accelerated implementation timing for the largest financial counterparties).

This article was written and updated as at 22 November 2016 and first published in Regulatory Intelligence by Thomson Reuters.

There has been significant progress on the EU margin rules in recent months. This article is intended to supplement `EMIR The new margin landscape' published in Global Financial Markets Insight issue 10 (Q2 2016) to give an overview of the new industry documentation as you consider how best to update your collateral arrangements in order to be ready for 1 March 2017.

Anticipated timetable

Following the European Supervisory Authorities publishing their Opinion on 8 September 2016, the European Commission formally adopted the EU margin rules on 4 October 2016. These were subsequently ratified by the European Parliament on 26 October 2016 and, at the time of writing, we await their ratification by the Council of the European Union. Following ratification, the EU margin rules will be published in the Official Journal of the European Union, and will come into force 20 days thereafter.

The largest financial counterparties (i.e. those with aggregate month-end average notional amounts (AANA) of non-centrally cleared derivatives for March, April and May 2016 exceeding 3 trillion) will then have one month to implement the rules (with respect to both initial and variation margin). For all other in-scope counterparties, the new variation margin rules will apply from 1 March 2017, while there will be a phased-in implementation with respect to initial margin from 1 September 2017 through to 1 September 2020 (depending on AANA).

The current expectation is that the Council of the European Union will ratify the EU margin rules on 21 November 2016. In which case, it is likely that the largest financial counterparties will face a mid-January 2017 implementation date. A midJanuary implementation would be favoured by the market as there had been some concern (voiced by ISDA among others) over implementation during the end of year `code freeze' (as it is traditionally difficult for the banks to make changes to their systems and models during this period). A mid-January implementation would avoid this, and at the same time should allow for a smooth transition before the general 1 March 2017 implementation deadline.

VM Protocol

In preparation for this regulatory change, on 16 August 2016, ISDA published the ISDA 2016 Variation Margin Protocol (the VM Protocol). The VM Protocol is intended to facilitate compliance with the new global rules relating to variation margin (including for the US, Canada and the member states of the EU).

The intention is that ISDA will produce separate supplements for each underlying regulatory regime (each such regime being a Protocol Covered Regime). At the time of writing, the VM Protocol covers the US (the PR and CFTC rules), Japan (the JFSA rules) and Canada (the OFSI rules), but importantly, not yet Europe.

The VM Protocol is a Questionnaire Protocol: in other words, adherents will need to complete the ISDA 2016 Variation Margin Protocol Questionnaire and elect one or more of the following three methods to match with counterparties. Note that the VM Protocol is only designed to work where there is a single Credits Support Annex (CSA) with respect to the underlying Master Agreement:

  • Amend Method - If the parties to a swap match under the Amend Method, and are parties to an existing CSA, then such CSA will be amended by the terms set out in the applicable form of amendment to the VM Protocol (being Exhibit NY-AMEND or Exhibit English-AMEND (each, a VM Amendment). The Amend Method would be used if the parties desire to use the terms of their existing CSA, as amended by the applicable VM Amendment, for all swaps, including swaps entered into before the applicable compliance date, with effect on the earliest applicable compliance date.
  • Replicate-and-Amend Method - If the parties match under the Replicate-and-Amend Method, and are parties to an existing CSA, then such CSA will be replicated to produce a separate CSA with the same terms as the existing CSA, plus the terms set out in the applicable VM Amendment. That is, if the parties match under the Replicate-and-Amend Method, the existing CSA (without any amendments) would apply to pre-compliance swaps and a new CSA (in the form of the existing CSA plus the terms set out in the applicable VM Amendment) would apply to post-compliance swaps.
  • New CSA Method - If the parties match under the New CSA Method, and the governing law of the underlying ISDA Master Agreement is the laws of the State of New York, then the parties are deemed to have entered into a new CSA with Paragraphs 1 through 12 being in the form of the 2016 CSA Form (NY law) and Paragraph 13 being in the form of the Exhibit NY-NEW to the VM Protocol (which contains a completed Paragraph 13 to the 2016 CSA Form (NY law) (see below)). The New CSA would apply to all post-compliance swaps, and if the parties seek to elect, pre-compliance swaps.

Similarly, if the parties match under the New CSA Method, and the governing law of the underlying ISDA Master Agreement is English law, then the parties are deemed to have entered into a new CSA with Paragraphs 1 through 10 being in the form of the 2016 CSA Form (English law) and Paragraph 11 being in the form of the Exhibit English-NEW to the VM Protocol (which contains a completed Paragraph 11 to the 2016 CSA (VM) Form (English law) (see below). The New CSA would apply to all post-compliance swaps, and if the parties seek to elect, precompliance swaps.

  • 2016 CSA (VM) Forms - As noted above, as part of this exercise, ISDA has further produced new credit support documentation for the posting of variation margin. Namely, on 16 August 2016, ISDA published the 2016 CSA (VM) Form (NY law) and the 2016 CSA (VM) Form (English law). Each new CSA is based on the existing ISDA 1994 CSA (Bilateral Form; ISDA Agreements Subject to New York Law Only) and the ISDA 1995 CSA (Bilateral Form - Transfer; ISDA Agreements Subject to English Law Only), as applicable. Key additional points to note are:
  • There are separate regulatory-compliant CSAs/CSDs for both initial and variation margin.
  • Each 2016 CSA (VM) Form is designed to be used for multiple regulatory regimes and capable of addressing different and potentially inconsistent regulations.
  • Each 2016 CSA (VM) Form incorporates the amendments introduced by the 2002 Master Agreement Protocol.
  • Modular approach - each 2016 CSA (VM) Form is designed to operate in combination with existing CSAs/CSDs under a single ISDA master.

This is only an introduction to some of the issues to be considered by in-scope entities in anticipation of the new margin rules. We have produced a more detailed analysis of the global margin rules and the impact of the VM Protocol to assist clients when considering how best to repaper their contractual documentation, and we are always happy to discuss this further.