NetOTC welcomes the proposed change – the additional flexibility should allow a more straightforward initial margin calculation while still preserving resilience to post-default stress.
While we understand the simplicity of a single “termination currency” approach, we are concerned about dis-incentivising real hedging of currency risk in the underlying OTC portfolio. To the extent that there are FX risk exposures in the underlying portfolio, there are two straightforward approaches to protecting against FX losses arising from the default of a counterparty:
i) Calculating the impact of stressed FX moves on the underlying portfolio and posting sufficient collateral to cover any losses at the appropriate quantile.
ii) Directly hedging the FX risk of the underlying OTC portfolio by posting collateral in the appropriate currency.
This second alternative has the advantage that it provides a direct hedge against losses that is model independent. Moreover, to the extent that the underlying portfolio has exposure to multiple currencies, it naturally encourages diversification of collateral.
If haircuts are imposed that dis-incentivise the posting of collateral in multiple currencies, economically rational hedging may be discouraged, worsening outcomes.
We ask that the wording allow the offset of FX risks between collateral and portfolio before haircuts against the termination currency are calculated.