Shearman & Sterling LLP | Financial Regulatory Developments Focus | Proposed Exemption From EU Margin Obligations for OTC Derivatives Novated to EU Counterparties in Preparation for a "No Deal" Brexit
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  • Proposed Exemption From EU Margin Obligations for OTC Derivatives Novated to EU Counterparties in Preparation for a "No Deal" Brexit
    11/29/2018
    The Joint Committee of the European Supervisory Authorities has published a final report and final draft Regulatory Technical Standards to amend the existing RTS on margin requirements for uncleared OTC derivative contracts. The ESAs are proposing the introduction of a 12-month exemption from the margin exchange obligations to facilitate the novation of uncleared OTC derivative contracts to EU counterparties in the event of a "no deal" Brexit. The European Market Infrastructure Regulation 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.

    On Brexit, U.K. firms will lose the passports that enable them to provide certain services across the EU. If the EU and the U.K. fail to reach an agreement on the U.K.'s exit from the EU and to the extent they are unable to avail themselves or equivalence, national perimeter regimes or reverse solicitation, U.K. firms may be unable to perform some of the operations for their derivatives contracts with EU clients. In preparation for this eventuality, firms may want to novate certain contracts to entities that are established and authorized in an EU27 member state. However, novation of an OTC derivatives contract may trigger the margin obligation and result in unexpected taxes or costs to the firms (arising from an event over which they have no control). To address this, the ESAs are proposing to amend the RTS on the margin obligation to introduce a time-limited exemption.

    This would apply for bilateral OTC derivatives contracts that have either been entered into or novated before the margin obligation became applicable. The exemption would only apply to a novation from a U.K. counterparty to an EU counterparty and would be available for a period of 12 months following the U.K.'s exit from the EU to provide firms with time to negotiate any novation and complete any necessary repapering.

    The exemption will not come into effect if the EU and U.K. agree the terms of the U.K.'s exit and the withdrawal agreement has entered into force. Similarly, it will not apply if the EU and the U.K. agree to extend the two-year negotiation period under the terms of the Treaty on European Union.

    The final draft RTS have been submitted to the European Commission for endorsement.

    View the final report and final draft RTS.

    View details of the proposed exemption from the clearing obligation.

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