Regulators undecided on initial margin rules for uncleared swaps

European regulators are still unsure to what extent swaps counterparties should be required to provide and collect initial margin on uncleared derivatives trades, and are considering three potential options.

The proposals were set out in a joint discussion paper published by the European Securities and Markets Authority, European Banking Authority and the European Insurance and Occupational Pension Authority.

The regulators state all derivatives users subject to the rules will likely have to post variation margin on uncleared swaps, but are less clear on whether and to what extent initial margin should be posted. The main stumbling block is liquidity – while the authorities agree that initial margin would reduce potential loss and increase stability within the derivatives market, they acknowledge the requirements could result in liquidity constraints and increase the cost of trading.

The paper describes three potential options for initial margin. The first requires all financial counterparties and non-financial counterparties that have breached a clearing threshold, as defined in the European Market Infrastructure Regulation, to post and collect initial margin.

The second option is for all prudentially-regulated financial counterparties to collect initial margin but not post it (unless they trade with another bank), and for non-prudentially-regulated financial users to post but not collect collateral.

This is similar to the approach proposed by US regulators last April, which requires swap dealers and major swap participants to collect initial margin, including on interdealer trades. European authorities point out that applying this option would prevent regulatory arbitrage with the US.

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