Legal issues of variation margin are the part of the broader spectrum of the collateral management under the EMIR Regulation.
According to Rticle 1(2) of the Commission Delegated Regulation (EU) 2016/2251 of 4 October 2016 supplementing Regulation (EU) No 648/2012 of the European Parliament and of the Council on OTC derivatives, central counterparties and trade repositories with regard to regulatory technical standards for risk-mitigation techniques for OTC derivative contracts not cleared by a central counterparty variation margin means 'the collateral collected by a counterparty to reflect the results of the daily marking-to-market or marking-to-model of outstanding contracts referred to in Article 11(2) of Regulation (EU) No 648/2012'.
Also the document of the Basel Committee on Banking Supervision, Board of the International Organization of Securities Commissions, Margin requirements for non-centrally cleared derivatives, September 2013 indicates that variation margin protects the transacting parties from the current exposure that has already been incurred by one of the parties from changes in the mark-to-market value of the contract after the transaction has been executed.
The amount of variation margin reflects the size of this current exposure.
It depends on the mark-to-market value of the derivatives at any point in time, and can therefore change over time.
The Margin requirements for non-centrally cleared derivatives adopted in March 2015 by the Basel Committee on Banking Supervision (BCBS) and the International Organization of Securities Commissions (IOSCO) upheld the approach to the above definition, and, moreover, indicated, "regular and timely exchange of variation margin represents the settlement of the running profit/loss of a derivative and has no net liquidity costs given that variation margin represents a transfer of resources from one party to another. The BCBS and IOSCO also recognise that the regular and timely exchange of variation margin is a widely adopted best practice that promotes effective and sound risk management".
Frequency of calculation and determination of the calculation date
According to the Regulation 2016/2251, counterparties must calculate variation margin at least on a daily basis.
For the purpose of determining the calculation date for variation margin the following rules, moreover, apply:
(a) where two counterparties are located in the same time-zone, the calculation is to be based on the netting set of the previous business day;
(b) where two counterparties are not located in the same time-zone, the calculation is to be based on the transactions in the netting set which are entered into before 16.00 of the previous business day of the time zone where it is first 16.00.
Article 12
Provision of variation margin
1. The posting counterparty shall provide the variation margin as follows:
(a) within the same business day of the calculation date determined in accordance with Article 9(3);
(b) where the conditions in paragraph 2 are met, within 2 business days of the calculation date determined in accordance with Article 9(3).
2. The provision of variation margin in accordance with paragraph 1(b) may only be applied to the following:
(a) netting sets comprising derivative contracts not subject to initial margin requirements in accordance with this Regulation, where the posting counterparty has provided, at or before the calculation date of the variation margin, an advance amount of eligible collateral calculated in the same manner as that applicable to initial margins in accordance with Article 15, for which the collecting counterparty has used a margin period of risk (‘MPOR’) at least equal to the number of days in between and including the calculation date and the collection date;
(b) netting sets comprising contracts subject to initial margin requirements in accordance with this Regulation, where the initial margin has been adjusted in one of the following ways:
(i) by increasing the MPOR referred to in Article 15(2) by the number of days in between, and including, the calculation date determined in accordance with Article 9(3) and the collection date determined in accordance with paragraph 1 of this Article;
(ii) by increasing the initial margin calculated in accordance with the standardised approach referred to in Article 11 using an appropriate methodology taking into account a MPOR that is increased by the number of days in between, and including, the calculation date determined in accordance with Article 9(3) and the collection date determined in accordance with paragraph 2 of this Article.
For the purposes of point (a), in case no mechanism for segregation is in place between the two counterparties, those counterparties may offset the amounts to be provided.
Calculation of variation margin
The amount of variation margin to be collected by a counterparty under EMIR must be the aggregation of the values calculated as a result of the process of marking-to-market on a daily basis the value of all outstanding contracts in the netting set,
minus
the value of all variation margin previously collected,
minus
the net value of each contract in the netting set at the point of entry into the contract, and
plus
the value of all variation margin previously posted.
‘Netting set’ is defined as "a set of non-centrally cleared over-the-counter (‘OTC’) derivative contracts between two counterparties that is subject to a legally enforceable bilateral netting agreement".
Provision of variation margin
The posting counterparty must provide the variation margin within the same business day of the calculation date.
Exceptionally, the posting counterparty must provide the variation margin within 2 business days of the calculation date where the conditions in Article 12(2) of the Regulation 2016/2251 are met (see box).
In the event of a dispute over the amount of variation margin due, counterparties must provide, in the aforementioned time frame at least the part of the variation margin amount that is not being disputed.
Initial margin management and segregation
Counterparties' internal procedures, legal arrangements and a collateral holding structure must ensure:
(a) daily valuation of the collateral;
(b) access to the received collateral where it is being held by a third party;
(c) the availability of unused collateral to the liquidator or other insolvency official of the defaulting counterparty;
(d) that non-cash collateral is transferable without any regulatory or legal constraints or third-party claims, including those of the liquidator of the collecting counterparty or third-party custodian, other than liens for fees and expenses incurred in providing the custodial accounts and other than liens routinely imposed on all securities in a clearing system in which such collateral may be held;
(e) that any unused collateral is returned to the posting counterparty in full, excluding costs and expenses incurred for the process of collecting and holding the collateral.
Any collateral posted as variation margin may be substituted by alternative collateral where all of the following conditions are met:
(a) the substitution is made in accordance with the terms of the agreement between the counterparties;
(b) the alternative collateral is eligible, as set out in the Regulation 2016/2251;
(c) the value of the alternative collateral is sufficient to meet all margin requirements after applying any relevant haircut.
Where non-cash collateral is held by the collecting party or by a third-party holder or custodian, the collecting counterparty must always provide the posting counterparty with the option to segregate its collateral from the assets of other posting counterparties.
Counterparties must perform an independent legal review in order to verify that the segregation arrangements meet the above requirements.
That legal review may be conducted by an independent internal unit, or by an independent third party.
Counterparties are required to provide evidence to their competent authorities of compliance with the requirement of the independent legal review in relation to each relevant jurisdiction and, upon request by a competent authority, must establish policies ensuring the continuous assessment of compliance.
EMIR reporting for variation margin
Companies are required to indicate in their EMIR transaction reports the value of the variation margin posted - Field 26 of the Table 1 of the Annex to the Commission Implementing Regulation (EU) 2017/105 of 19 October 2016 amending Implementing Regulation (EU) No 1247/2012 laying down implementing technical standards with regard to the format and frequency of trade reports to trade repositories according to Regulation (EU) No 648/2012 of the European Parliament and of the Council on OTC derivatives, central counterparties and trade repositories (variation margin received - Field 30).
Variation margin in the CCP framework
Legal definition of variation margin for the purposes of the CCP framework is also contained in Article 1(6) of Commission Delegated Regulation No 153/2013 of 19 December 2012 supplementing Regulation (EU) No 648/2012 of the European Parliament and of the Council with regard to regulatory technical standards on requirements for central counterparties pursuant to which 'variation margin' means 'margins collected or paid out to reflect current exposures resulting from actual changes in market price' (this is connected with the definition of 'margins' as a broader category, which is set out in the Article 1(4) of the said Regulation, stipulating that 'margins' are 'margins as referred to in Article 41 of Regulation (EU) No 648/2012 which may include initial margins and variation margins').
Other issues
When it comes to group entities, in the USA, house and affiliates accounts' margins are posted together in a house account, while in the EU affiliate accounts are margined as clients (ESMA Discussion Paper of 26 August 2015, Review of Article 26 of RTS No 153/2013 with respect to client accounts (ESMA/2015/1295), p. 12).
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Documentation |
ESAs' Second Consultation on margin RTS for non-cleared derivatives of 10 June 2015 (JC/CP/2015/002)
Margin requirements for non-centrally cleared derivatives, September 2013, BCBS/IOSCO
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Links |
Client segregation and portability under EMIR
Interrelations between margins and haircuts