On 3 April 2020, the Basel Committee on Banking Supervision (“BCBS”) and the International Organization of Securities Commissions (“IOSCO”) announced that, due to the impact on the global financial system of the rapid spread of coronavirus (COVID-19), they are suggesting a one-year extension for the completion of the final two implementation phases of the initial margin (“IM”) requirements for non-centrally cleared derivatives. As a result, it is probable that, in Europe, the United States and Japan, the final two phases of the IM requirements, previously likely to end on 1 September 2020 and 1 September 2021, will each be delayed by one year.
As part of the global response to the 2008 financial crisis, BCBS and IOSCO developed a framework (the “BCBS/IOSCO Framework”) in which covered entities that are parties to non-centrally cleared derivatives would exchange IM subject to a threshold of up to €50 million. Influential in the development of margin rules in Europe, the United States, Japan and elsewhere, the BCBS/IOSCO Framework provided that IM requirements should come into effect on a phased basis starting on 1 September 2016, when IM requirements would apply to any covered entity (a financial firm or a systemically important non-financial entity) transacting non-centrally cleared derivatives with another covered entity, where both entities belonged to a group whose aggregate month-end average notional amount (“AANA”) of non-centrally cleared derivatives exceeded €3.0 trillion. Currently, we are in phase 4 of the implementation of rules based on the BCBS/IOSCO Framework, whereby, in Europe, IM requirements apply to pairs of derivatives counterparties that are both covered entities belonging to a group whose aggregate month-end average notional amount of non-centrally cleared derivatives exceeds €0.75 trillion.
In July 2019, BCBS and IOSCO suggested the extension of the original final phase of IM implementation (for counterparties in groups with AANA exceeding €8 billion) to 1 September 2021, and the creation of a penultimate phase (for counterparties in groups with AANA exceeding €50 billion) with a deadline of 1 September 2020.
On 26 March 2020, the International Swaps and Derivatives Association (ISDA) published a letter that it submitted on behalf of 21 industry associations and their members to BCBS, IOSCO and global regulators. The letter requested a suspension of the current timeline for the IM phase-in to allow market participants to focus their resources on ensuring continued access to the derivatives market during the ongoing COVID-19 pandemic. The letter did not propose particular revised compliance dates but requested that revised deadlines be set once the overall impact of COVID-19 is known. The letter also requested that, once markets are back to normal and new phase-in dates are being set, sufficient lead time be provided in order to complete implementation in a phased and reasonable period of time.
Following ISDA’s request and representations from other market participants, BCBS and IOSCO made their 3 April 2020 announcement referred to above.
Under the revised BCBS/IOSCO Framework, the final two phases of the IM requirements that were due to be completed on 1 September 2020 and 1 September 2021, respectively, have been delayed by one year. Therefore, under the framework, from 1 September 2021, any covered entity belonging to a group whose AANA of non-centrally cleared derivatives for March, April, and May of 2021 exceeds €50 billion will be subject to the IM requirements when transacting with another covered entity that meets that condition. From 1 September 2022, any covered entity belonging to a group whose AANA of non-centrally cleared derivatives for March, April, and May of 2022 exceeds €8 billion will be subject to the IM requirements. IM requirements do not apply to any covered entity belonging to a group whose AANA of non-centrally cleared derivatives for March, April, and May of a particular year is €8 billion or less.
The other elements of the BCBS/IOSCO Framework remain unchanged.
Margin requirements for non-centrally cleared derivatives have been phased in under the risk mitigation rules under Article 11 of the Regulation 648/2012 (“EMIR”) from February 2017 and under Commission Delegated Regulation 2016/2251 (the “Delegated Regulation”). EMIR was amended by a new regulation (the “EMIR Refit Regulation”) which came into effect from July 2019 and which granted power to the European Supervisory Authorities (“ESAs”) to develop draft regulatory standards (“RTS”) to specify supervisory procedures to ensure initial and ongoing validation of risk management procedures that counterparties are required to carry out, by inserting a new Article 11(15)(aa) into EMIR.
Subject to certain exceptions, the margin requirements apply to any entity which is an EMIR “financial counterparty” or an “above-threshold” non-financial counterparty (“NFC”), i.e. an NFC that meets one of a number of prescribed thresholds of aggregate notional amounts of different classes of derivatives. Binding Technical Standards set out detailed requirements relating to the provision of collateral, including the phase-in timings when provisions relating to IM requirements apply.
In December 2019, the ESAs published a final report setting out new draft regulatory technical standards (“RTS”) on the EMIR margining requirements which proposed a number of amendments to the Delegated Regulation, including taking into account the BCBS/IOSCO Framework. These RTS proposed an extension of the implementation of the IM requirements in relation to non-centrally cleared derivatives in line with the then-applicable BCBS/IOSCO timetable and with the same thresholds, and would accordingly delay the final phase of IM implementation until 1 September 2021.
These revised RTS were expected to be finalised and come into force prior to September 2020 but this has not yet occurred. We would expect the finalised RTS now to take into account the revised timetable set out in the revised BCBS/IOSCO timetable announced on 3 April 2020, delaying the final phases of implementation to 1 September 2021 and 1 September 2022, but this has not yet been confirmed.
The United Kingdom ceased to be a member of the European Union with effect from 11pm on 31 January 2020. However, under the terms of the UK’s withdrawal from the EU, a transition period came into effect on that date and is due to end on 31 December 2020. During the transition period, the United Kingdom will continue to be treated as if it were still an EU Member State for the purposes of market access for goods and services (including financial services) and related EU law will continue to be applicable to and in the United Kingdom. Therefore, for the time being, the UK remains subject to EMIR and other EU financial regulation. Although it is not yet clear whether or not the transition period will be extended after 31 December 2020 or what other arrangements may apply after that date, it is likely that the UK will continue to apply provisions that are consistent with the BCBS/IOSCO Framework relating to IM highlighted above.
In the United States, the prudential banking regulators (the “Prudential Regulators”), responsible for the margin regulations applicable to swap dealers that are banks subject to their prudential supervision, and the Commodity Futures Trading Commission (the “CFTC”), responsible for the margin regulations applicable to other swap dealers, have not yet confirmed that they will follow the one-year COVID-19-related extension for IM requirements suggested by BCBS and IOSCO. However, CFTC Chairman Heath Tarbert has been quoted as stating that if there is a consensus among regulators throughout the G20 jurisdictions, the CFTC will follow that consensus. It seems likely that in due course both the CFTC and the Prudential Regulators will follow BCBS and IOSCO’s suggestion to extend the remaining IM requirements by one year.
In accordance with the previous amendment to the phase-in schedule under the BCBS/IOSCO Framework, both the CFTC and the Prudential Regulators have proposed (but have not yet finalised) rules that would delay by one year the date by which swap dealers must comply with IM requirements in connection with uncleared swaps with certain smaller financial end users.
Under the existing phase-in schedules for both the CFTC’s margin rules and the Prudential Regulators’ rules for uncleared swaps, September 1, 2020 is the compliance date for IM requirements for swaps between swap dealers and financial end users that, combined with their relevant affiliates, have $0.75 trillion or less in average daily aggregate notional amount of uncleared swaps, uncleared security-based swaps, foreign exchange forwards and foreign exchange swaps. The rules proposed by both the CFTC and the Prudential Regulators would divide such financial end users into two groups. For one group, consisting of financial end users with more than $50 billion (but $0.75 trillion or less) in average daily aggregate notional amount of such transactions, the compliance date would remain September 1, 2020. For a second group, consisting of financial end users with $50 billion or less (but more than $8 billion) in average daily aggregate notional amount of such transactions, the compliance date for IM requirements would be delayed by one year, until September 1, 2021.
Assuming the CFTC and Prudential Regulators follow the further one-year delay suggested by BCBS and IOSCO in connection with COVID-19, the compliance dates for swap dealers in relation to swaps with those two groups of financial end users will be pushed back to September 1, 2021 and September 1, 2022.
In Japan, the Financial Services Agency (the "FSA") proposed draft amendments to the Cabinet Office Order on Financial Instruments Business (the “Cabinet Office Order”) under the Financial Instruments and Exchange Act (Act No. 25 of 1948, as amended) on April 15, 2020. The proposal intends to update the implementation phases of IM requirements for non-centrally cleared derivatives, in accordance with group-based aggregate month-end average notional amounts, to be consistent with the one-year extension of the implementation phases agreed to under the revised BCBS/IOSCO Framework stated above. The FSA has asked for public comments on the proposal by no later than May 18th 2020 and it is likely that the proposed amendment will be finalised around June 2020.
In line with the BCBS/IOSCO Framework, the Cabinet Office Order provides for phase-in implementation periods for IM during which IM obligations apply to a given entity only if certain thresholds are met by the average of the month-end aggregate notional amounts during the preceding three months of the entity’s non-cleared OTC derivatives, OTC commodity derivatives and physically settled foreign exchange forwards and swaps (determined on a consolidated group basis). Based on this principle, IM obligations have been applied to entities with an initial threshold of ¥105 trillion or greater since September 1, 2019 (phase 4). Under the existing phase-in schedules, IM obligations will be applied to entities meeting a threshold of ¥7 trillion from 1 September 2020 (phase 5), and to entities meeting a threshold of ¥1.1 trillion from 1 September 2021 (phase 6).
If the proposed draft amendment is finalised, however, the start dates of phase 5 and phase 6 would each be delayed by one year.
The changes in the implementation timeline suggested by the BCBS/IOSCO Framework will be welcome to market participants, although it is hoped that BCBS and IOSCO will be open to further changes to the extent necessary. We expect that regulators in the EU, United States, Japan and elsewhere will implement the changes suggested by BCBS and IOSCO.
 In 2011, the G-20 group of countries requested that BCBS and IOSCO develop, for consultation, consistent global standards for margin requirements for uncleared derivatives. The BCBS/IOSCO Framework, the result of that request, does not have the force of law unless and until implemented in applicable national laws.