EU Moves to Remove Physically-Settled FX Forwards from Variation Margin Requirements

The Joint Committee of the European Supervisory Authorities has announced a review of the Regulatory Technical Standards under the European Market Infrastructure Regulation which include the requirement to exchange variation margin for physically-settled FX forwards. EMIR requires counterparties to uncleared OTC derivative transactions to implement risk mitigation techniques to reduce counterparty credit risk. The RTS prescribe required margin amounts to be posted and collected and the methodologies by which the minimum amount of initial margin and variation margin should be calculated, as well as listing securities eligible as collateral, such as sovereign bonds, covered bonds, some securitization instruments, corporate bonds, gold and some equities. The variation margin requirements have applied to all counterparties since March 1, 2017 although they will only be applicable for physically-settled FX forwards from January 3, 2018.

Market participants have experienced difficulties in exchanging VM, in particular, in transactions with end-users. In addition, the EU's implementation of the international standards on margin exchange is more extensive than that in some other jurisdictions.

The Council of the European Union, in considering the Commission's proposals to amend EMIR, appears to agree with the ESAs. The Council is proposing to add a recital to EMIR to the effect that the requirement to exchange VM for physically-settled FX forwards should be limited to the most systemically important counterparties, so as to avoid differences between EU laws and international standards.

The ESAs note that amending the RTS will require the agreement of the European Commission, the European Parliament and the Council. The ESAs intend to submit proposed revisions to the RTS to the European Commission before the end of the year. In the meantime, the ESAs encourage national regulators to "apply their risk-based supervisory powers in their day-to-day enforcement of applicable legislation in a proportionate manner" The Joint Committee of the ESAs comprises the European Securities and Markets Authority, the European Banking Authority and the European Insurance and Occupational Pensions Authority.

View the ESA's announcement.