Banks must back trades in the $633 trillion market for swaps and other over-the-counter derivatives with additional collateral as global regulators seek to choke off opportunities for excessive risk taking.
The plans jointly issued by two groups of international standard-setters target swaps traded outside of clearinghouses and would ensure lenders have safeguards in place when a trading partner defaults. The regulators said they scaled back some of the proposals to address bank concerns that the rules would restrict lending.
Nations are seeking to toughen and align rules for over-the-counter derivatives, which became a target for oversight after the 2008 collapse of Lehman Brothers Holdings Inc. and the rescue of American International Group Inc. (AIG:US), two of the largest traders of credit-default swaps.
Systemically important firms “will have to exchange initial and variation margin commensurate with the counterparty risks,” the Basel Committee on Banking Supervision and International Organization of Securities Commissions said in an e-mailed statement. The rules will be phased in over a four-year period beginning in December 2015, they said.
Lenders including HSBC Holdings Plc (HSBA), UBS AG (UBSN) and Deutsche Bank AG (DBK) warned earlier this year that a provisional version of the plans would cause a global liquidity crunch.
Changes were made in a bid to address banks’ concerns, the Basel group said. Foreign exchange swaps and forwards contracts that are physically settled will be exempt from the bulk of the measures, as will be deals worth less than 50 million euros ($66 million).
Traders will also be permitted some limited scope to use collateral they are given to back other trades, the Basel group said.
Today’s rules are part of a broader push to toughen margin requirements as two other groups of regulators last month focused on limiting the way banks can recycle collateral.
The Financial Stability Board last week called for brokers to face restrictions on using client assets as collateral for other trades, while European Union regulators are weighing steps to limit the number of times the same piece of collateral can be passed on.
The posting of collateral is when a party to a trade hands over assets to their counterparty as a guarantee that they will not be left empty handed should the trader default on their obligations.
Initial margin is collateral posted at the beginning of a trade. Variation margin may be exchanged daily to offset risk from incremental price movements.
Under the rules published today both parties to a trade would be required to post initial and variation margin, once the 50 million euro threshold is breached.
The threshold, which concerns the “initial margin,” would be measured against all the non-centrally cleared OTC derivative trades between the two companies.
The rules would apply initially to the “most active and most systemically important derivatives market participants,” with their scope gradually expanding over the phase-in period.
“A broad array” of securities will be allowed to count as collateral under the rules, “further reducing the liquidity impact,” the standard setters said. Eligible securities include cash, high-quality government and corporate debt, covered bonds, equities and gold, according to a non-exhaustive list prepared by the regulators.
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