Variation margin exchange for physically-settled FX forwards under EMIR


The European Supervisory Authorities (ESAs) have been made aware of challenges for certain counterparties to exchange variation margin for physically-settled FX forwards by 3 January 2018. Based on the material presented to the ESAs, the implementation appears to mainly pose a challenge regarding transactions with certain end-users.

The requirement to exchange variation margin for physically-settled FX forwards is part of a globally agreed framework ('the international standards'), which aims at ensuring safer derivatives markets by limiting the counterparty risk from derivatives trading partners. The international standards state that variation margining of physically-settled FX forwards is both an established practice among significant market participants and that it is a prudent risk management tool that limits the build-up of systemic risk, and thus that variation margining should apply to physically-settled FX forwards.

The international standards recommend implementing this requirement by way of national regulation or supervisory guidance. The ESAs followed the option of implementing these international standards by way of regulation applicable to transactions in the scope of EMIR. However, it became apparent that the adoption of the international standards in other jurisdictions via supervisory guidance has led to a scope of application that is more limited than the scope the ESAs have proposed.

From a legal perspective, neither the ESAs nor competent authorities (CAs) possess any formal power to disapply directly applicable EU legal text. Therefore, any changes to the application of the EU rules would formally need to be implemented through EU legislation. 

In light of this, the Boards of the ESAs are currently undertaking a review of the Regulatory Technical Standards on risk mitigation techniques for OTC derivatives not cleared by a central counterparty (RTS) and develop draft amendments to these RTS that align the treatment of variation margin for physically-settled FX forwards with the supervisory guidance applicable in other key jurisdictions.

Specifically, the amendment of the RTS and their subsequent implementation would reiterate our commitment to apply the international standards, and require the exchange of variation margin for physically-settled FX forwards in a risk based and proportionate manner. In particular, this would most likely imply that the scope should cover transactions between institutions (credit institutions and investment firms). In addition for some institution-to-non-institution transactions the competent authorities should consider the actual risk that the exchange of variation margins would mitigate and whether non-institutions might face additional risks related to the daily exchange of variation margin.

Once the Boards of the ESAs have finalised its current review, and assuming a solution is reached, then these draft amendments will be submitted to the European Commission within one month from this communication.

Accordingly, as regards difficulties that in particular certain end-users are facing, the ESAs expect competent authorities to generally apply their risk-based supervisory powers in their day-to-day enforcement of applicable legislation in a proportionate manner.