Regulators ease derivatives rule to avoid harming economy
LONDON (Reuters) – Global regulators have eased the impact of new rules designed to make the $630 trillion derivatives market safer as they seek to avoid too-tight controls on the sector that some banks argue could harm economic recovery.
The Basel Committee of regulators and central bankers published their final rule for requiring banks and brokerages to post an initial margin on trades in derivatives known as swaps, if those trades don’t pass through a “clearing house” which in itself generates a backup if one party to the trade goes bust.
The reform, which now envisages a threshold on the value of a trade below which no collateral is required, is part of a wider shake up of derivatives which is underway among the top 20 economies (G20), including the mandatory clearing of trades where possible, and for all transactions to be recorded. Regulators want to apply lessons from the 2007-09 financial crisis in which the opaqueness of derivatives such as credit default swaps – used to insure against falls in bond prices – played a central part in creating market uncertainty.
Use of a clearing house means trades are backed by a default fund as insurance and the aim of an initial margin – where cash or top quality government bonds are used to back a trade – is to provide a similar safety cushion.
The final rule was published on Monday ahead of a summit of G20 leaders in Russia on Thursday and Friday who will update themselves on progress in regulatory reforms.
The new rule will require traders in derivatives to in many cases post an initial margin for the first time. They already post a so-called variation margin that takes into account daily changes in the value of the swaps contract.
Yet some banks have warned that the new rule, coupled with other reforms forcing traders and banks to use more collateral, will create a shortage of top quality collateral.
Industry officials say this would make some users avoid buying derivatives to insure against risks such as adverse changes in currencies, and hit availability of collateral in other markets for financing the economy.
“The Basel Committee … acknowledge that the margin requirements are new to the market and that their precise impact will depend on a number of factors and market conditions that will only be realized over time as the requirements are put into practice,” the regulators said in a statement.
To lighten demand for collateral, Basel has decided to introduce a threshold of 50 million euros ($65.9 million) on the value of a deal, below which a firm could decide not to collect an initial margin.
Regulators hope the introduction of an additional margin on uncleared trades will provide a financial incentive for banks and other users to clear their transactions.
The final framework also allows a wider array of eligible collateral for initial margins than was previously envisaged.
Banks and brokerages would be able to re-use initial margin collateral, a process known as re-hypothecation, but only once.
The rule will in addition be phased in over a longer period than originally set out, starting in December 2015 for only the very biggest derivatives dealers, and rolled out for the rest of the market over four years.
Other changes from the draft version include an exemption for physically settled foreign exchange forward contracts and swaps from initial margin requirements.
Earlier this year Basel scaled back its new rule requiring banks to build up a buffer of liquidity reserves, again to ease demand for top-quality government bonds.