Response to second Joint Consultation on draft RTS on risk-mitigation techniques for OTC-derivative contracts not cleared by a CCP
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Furthermore if contrary to our recommendations the requirement to exchange variation margin on foreign exchange forwards and swaps remains, then if one counterparty is out of the money on a transaction leading up to settlement date, it will have been obliged to collateralise the exposure of the trade. On settlement date, the final payment will also be required, however, due to the nature of the collateralisation process, the collateral would not have yet been returned and the collateral could not be able to be used to facilitate settlement of the transaction; thus exposing the paying party to a temporary period of uncollateralised risk, which may also create cash-flow liquidity problems for the firm. There would therefore be additional requirements on funds to hold cash to the level of double the negative exposure of a particular FX forward, which would limit the fund’s ability to trade and be operationally cumbersome.
Respondents are invited to comment on the proposal in this section concerning the timing of calculation, call and delivery of initial and variation margins.
We have two concerns with respect to the proposal concerning the timing of calculation, call and delivery of variation margin with respect to foreign exchange forwards and swaps. To us it seems perverse that pension funds undertaking currency hedging should be required to comply with variation margin requirements, on a timescale faster than that being applied to initial margin requirements, and to have to do so despite a likely aggregate notional amount of non-centrally cleared derivatives which would wholly exempt them from initial margin requirements. Since the requirement to collect and receive collateral on a daily basis will be sufficiently operationally burdensome to deter some clients altogether, this proposal seems set to increase not decrease risk within EU pension funds. For more details please see our attached document entitled “Record Second Consultation Response 10 July 2015.pdf”.Furthermore if contrary to our recommendations the requirement to exchange variation margin on foreign exchange forwards and swaps remains, then if one counterparty is out of the money on a transaction leading up to settlement date, it will have been obliged to collateralise the exposure of the trade. On settlement date, the final payment will also be required, however, due to the nature of the collateralisation process, the collateral would not have yet been returned and the collateral could not be able to be used to facilitate settlement of the transaction; thus exposing the paying party to a temporary period of uncollateralised risk, which may also create cash-flow liquidity problems for the firm. There would therefore be additional requirements on funds to hold cash to the level of double the negative exposure of a particular FX forward, which would limit the fund’s ability to trade and be operationally cumbersome.