On December 12th 2017 the European Supervisory Authorities (“ESAs”) published draft regulatory technical standards amending Regulation (EU) 2016/2251 supplementing Regulation (EU) No. 648/2012 (“EMIR”) with regard to regulatory technical standards on risk-mitigation techniques for OTC derivative contracts not cleared by a central counterparty.
In their final report the ESAs noted that the requirement to exchange variation margin for physically settled foreign exchange forwards is part of a globally agreed framework which aims to ensure safer derivative markets by limiting the counterparty risk from derivatives trading partners. This requirement has been implemented in the EU through Regulation (EU) 2016/2251. However, the ESAs have been made aware of certain difficulties and challenges faced by certain counterparties as the adoption of international standards in other jurisdictions (outside of the EU) via supervisory guidance (as opposed to a directly applicable Regulation) has led to a more limited scope of application than the scope proposed by Regulation 2016/2251.
The aim of the proposed amendments is to align the treatment of variation margin for physically settled foreign exchange forwards with the supervisory guidance applicable in other key jurisdictions and to limit the requirement to exchange variation margin to transactions between institutions i.e. credit institutions and investment firms.
As such the proposal is to amend Regulation (EU) 2016/2251 to specifically exclude physically settled foreign exchange forwards from the requirement to post or collect variation margin when at least one of the counterparties is not an institution. This is therefore of particular relevance to funds (both UCITs and AIFs) carrying out currency hedging.
Since the amended RTS will only enter into force after January 3rd 2018, when the requirement to exchange variation margin under Regulation (EU) 2016/2251 enters into force, the ESAs expect national competent authorities to apply the rules in a proportionate and risk-based manner until the amended RTS enter into force. As such it is expected that the CSSF will not insist on UCITs or AIFs exchanging variation margin for any foreign exchange forwards they may enter into.
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