Forex forward users delay VM plans amid uncertainty

Users of foreign exchange forwards in Europe say they will postpone plans to start margining their trades while waiting to find out whether regulators will delay or scrap the requirement.

Europe is alone among the biggest derivatives jurisdictions in requiring buy-side users of certain forex forwards to post variation margin on new trades. A number of these firms were planning to start posting variation margin before the regime begins on January 3, but with expectations growing that regulators are poised to drop the rule, many users are now putting these plans on ice.

“We’re preparing to postpone any go-live for the short term until we see what comes out,” says an investment manager at one UK-based asset manager.

Two of the three European Supervisory Authorities told Risk.net on November 20 that they were amending the rules requiring financial counterparties to start posting variation margin on new physically settled forwards from next year. The Council of the EU last week proposed to scrap the requirement altogether for buy-side entities. This has led to speculation that national regulators will turn a blind eye to compliance with the rules if they are due to be dropped anyway.

James Wood-Collins, chief executive officer of Record Currency Management in Windsor, says the company had arranged staggered starts for its clients to avoid an end-of-year bottleneck. But given the uncertainty, it will now look to amend collateral agreements, known as credit support annexes (CSAs), to postpone the effective date.

“We’re pushing many of those back to January 3, so for clients who haven’t started margining we’re buying as much time as possible,” says Wood-Collins.

This may go as far as making the effective date ‘to be confirmed’ in collateral agreements: “In a funny way, that would sort of mirror the way the rules come in,” he adds.

If the collateral requirement is delayed or dropped, Wood-Collins says some fully documented clients might keep margining anyway, but most will likely seek to avoid it.

“My sense is that most of our clients, given the choice, will choose to revert to uncollateralised. But it’s possible that some may recognise, having put the work and effort in to secure margining on industry-standard terms, that does then give a greater level of counterparty risk mitigation. If managing liquidity isn’t too burdensome then they may continue,” he says.

My sense is that most of our clients, given the choice, will choose to revert to uncollateralised

James Wood-Collins, Record Currency Management

“I do think that’ll be the minority, because for most of our clients, typically particularly pension funds, they do not have access to surplus liquidity. Keeping cash or liquid assets available to meet margin requirements does have some knock-on effects,” he adds.

Some larger asset managers that have been collateralising other non-cleared derivatives since the margin rules came in on March 1 would have had carve-outs in their CSAs specifically for forex forwards. This would be linked to the date the forex forwards margin rule came into effect.

“What most people did was carve them out and put something in that said unless there is [a delay] they will be collateralised,” says a derivatives partner at one international law firm.

However if national regulators grant forbearance to buy-side users, this alone would not change that start date, because the law itself would need to change. In such a situation counterparties may simply agree not to exchange variation margin, given the rules wouldn’t really be coming into effect.

“Technically, [counterparties] can be asked or be required to be collateralised because regulators won’t change the text before the January 3. But I think people will take the forbearance, not collateralise those transactions and wait until the rules are changed,” says the partner.

Other clients using regular CSAs might look to terminate contracts they have signed. “It’s sort of pot luck in terms of whether you have already signed a document or you haven’t in terms of when the announcement comes. But I think we will see some counterparties coming back and asking to tear up documents where they no longer need them,” says the derivatives partner.

Record’s Wood-Collins says banks have been unwilling so far to terminate CSAs, but as clients trade on their CSAs on an agency basis, they can retain the documents with the dealers and simply remove client names that do not want to collateralise.

He says Record is not planning to slow down the negotiation process with banks that have not yet signed a CSA with the company, or for clients that have not yet completed preparations for margining - the danger being that there is no delay or cancellation of the margin requirement.