The Financial Supervisory Service (FSS) of Korea published the draft 'Guidelines on Margin Requirements for Non-Centrally Cleared OTC Derivatives Transactions'1 (Guidelines) on 14 December 2016 and invited comments to be submitted by 2 January 2017. This forms part of global efforts to reduce systemic risk relating to OTC derivatives transactions and is aimed at implementing the 'Margin Requirements for Non-Centrally Cleared Derivatives' (Recommendations) published in March 2015.
The Recommendations and, by extension, the Guidelines, seek to reduce systemic risks inherent in OTC derivatives which are not centrally cleared through a central counterparty (CCP) by requiring all financial institutions and systemically important non-financial institutions to receive and deliver additional margin in respect of outstanding OTC derivatives transactions which are not cleared through a CCP.
The Guideline applies to all OTC derivatives transactions which are not cleared through a CCP. FX forward and swap and currency swap which are physically settled are excluded.
Financial institutions such as bank, financial investment company, insurance company, etc. and on/off-shore collective investment schemes trading OTC derivatives shall be obliged to comply with the Guidelines. Non-financial company corporations, the Bank of Korea, public institutions, international institutions such as BIS, etc. are excluded from the scope.
C. Phase-in Timetable
1. Initial Margin
|2017.9.1.||Aggregate Outstanding Transactions ≥ KRW3,000 trillion|
|2018.9.1.||Aggregate Outstanding Transactions ≥ KRW2,000 trillion|
|2019.9.1.||Aggregate Outstanding Transactions ≥ KRW1,000 trillion|
|2020.9.1.||Aggregate Outstanding Transactions ≥ KRW10 trillion|
2. Variation Margin
|2017.3.1.||Aggregate Outstanding Transactions ≥ KRW10 trillion|
"Aggregate Outstanding Transactions" is the simple
average of yearly second quarter month-end notional amounts
aggregating all outstanding amounts of the financial group.
Exchange of initial margin shall apply to new contracts executed after each relevant application date.
* For variation margin only, the relevant institutions shall be allowed 3 months from each Implementation Dates to prepare for implementation.
D. Eligible Collateral/Haircut
Cash, gold, government bonds, foreign government bonds, high quality corporate bonds, listed shares shall be eligible collateral. Shares issued by a party itself will not be treated as eligible collateral. Haircut rates have been published but the Guidelines also allow for parties to use its internal standards as long as consistent rates are applied for each type of eligible collateral.
E. Margin Calculation etc.
1. Margin Calculation
- Initial margins can be calculated by either the 'standard initial margin calculation model' or a quantitative portfolio model developed autonomously by a party. The two models cannot be used as alternatives depending on which is more favourable under the circumstances but a party must elect one and use it consistently. An entity wishing to use its internal quantitative model approved by a foreign supervisor must report the quantitative model name and the fact of approval to the FSS.
- Variation margin must be calculated in a consistent way in relation to a counterparty and reflect the current exposure related to the portfolio and may either be directly calculated by an entity's internal model or outsourced to a third party. Daily margin calculation is recommended to efficiently manage exposure for market fluctuations.
2. Threshold and Minimum Transfer Amount (MTA)
- Initial Margin
- Threshold: not greater than KRW 65 billion
- MTA: not greater than KRW 1 billion
- Variation Margin
- Threshold: zero
- MTA: not greater than KRW 1 billion
Initial margin shall be exchanged on a gross basis whereas variation margin shall be exchanged on a net basis.
1. Intra-group margining
Margin must be exchanged based on the Guidelines for transactions within a financial group. However, the Guidelines will not apply to a financial institution which has in place the system to integrally manage risks of the financial group.
2. Substituted compliance
Substituted compliance will be permitted for transaction between 'foreign established financial institutions' which comprise of (i) foreign financial institutions established outside Korea, (ii) Korean branches of foreign financial institutions, and (iii) subsidiaries of Korean financial institutions established outside Korea. This is conditional on the FSS recognizing the equivalence between the Guidelines and the margin rules of the relevant foreign supervisory bodies.
3. Dispute Mediation
The entity will need to agree with its counterparty detailed procedures to detect, record and monitor disputes concerning confirmation, valuation and exchange of margin for OTC transactions. In addition, it must prepare dispute resolution procedures.
The FSS has invited interested parties to provide comments and feedback on the Guidelines by close of business on 2 January 2017.
Originally published FIG Legal Update, December 2016
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.