Regulators row back on collateral rules for derivatives

Fri Feb 15, 2013 6:00pm EST

* Basel publishes revised margin plan for consultation

* Proposes phase-in for initial margin from 2015

* New threshold proposed to slash collateral needs

By Huw Jones

LONDON, Feb 15 (Reuters) - Global regulators have proposed cutting back how much collateral banks and other users of off-exchange financial derivative instruments must have to back their trades in a bid to avoid markets tying up too much capital as economies struggle.

After the collapse of Lehman Brothers bank and the near-death experience of insurer AIG in 2008 world leaders agreed there should be wider use of collateral to back such derivatives transactions to make the $640 trillion market safer.

The reform covers derivatives traded outside a formal market, such as credit default swaps and interest rate swaps. The trading is dominated by some 15 banks but energy and agricultural companies also use such derivatives to insure against adverse price moves in markets.

The Basel Committee, a group of banking regulators from the Group of 20 (G20) leading economies who called for the reforms, proposed last year that banks and other users of such derivatives post an initial margin on their trades, if the trades are not cleared, meaning they are not underwritten by a central counter-party to each side of the trade.

The G20 said there should be an incentive to clear trades, suggesting they want higher collateral requirements on uncleared transactions.

But banks have warned of a "collateral crunch" because of the huge demand the new rules will create for cash and top quality assets like government bonds to back trades.

On Friday the Basel Committee published a revised proposal that signalled a major shift in thinking by introducing a threshold so the rules tie up less collateral.

"Several features of the near-final proposal are intended to manage the liquidity impact of margin requirements on financial market participants," the Basel Committee said.

Banks and other users of uncleared derivatives would still have to post an initial margin, but only on net exposures worth more than 50 million euros.

"The results of a quantitative impact study conducted in 2012 indicate that application of the threshold could reduce the total liquidity costs by 56 percent relative to a margining framework with a zero initial margin threshold," the committee said in a statement.

The revised proposals also include two-way initial margins, meaning each side of the transaction must post an initial margin - a first for many market participants.

The committee is also proposing a four-year phase-in from 2015 for the initial margin requirement so that only big dealers of derivatives would post initial margins in the first year.

The regulators are also asking if the mandatory use of variation margins, to cover day-to-day changes in the value of the exposures, should be phased in over several years rather than have a "big bang" introduction in 2016.

Variation margins, unlike initial margins, are applied widely throughout the market and are less controversial.

The scaling back of the initial margining plans mirrors a similar rowback by the committee in January when it eased its first, global bank liquidity rule by introducing a phase-in period.

The reforms to bank liquidity and derivatives were agreed by world leaders in 2009 when they expected economies to by now be recovering from the 2007-09 financial crisis.

As economies still struggle, policymakers have become more sympathetic to warnings from banks that they cannot comply with all the new rules quickly and keep lending to the economy.

The committee is also asking whether margin treatments for physically-settled foreign exchange forwards and swaps contracts should remain part of Basel margining rules.

Such foreign exchange contracts have been given exemptions in the United States from new U.S. derivatives trading rules, making it harder to have a single global rule for that part of the market.

The Basel committee is now expected to finalise the margining rules by September for the G20's next summit in St. Petersburg, Russia.

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