FCA and PRA consult on amendments to UK Margin Rules under UK EMIR

On 9 March 2021, the FCA and the PRA launched a joint consultation (the Consultation) on proposed amendments to the margin requirements applicable to non-cleared derivatives under EU Regulation 648/2012 (EU EMIR) and EU Delegated Regulation 2016/2251 (the EU Margin Rules) as each has effect in domestic law (UK EMIR and the UK Margin Rules, respectively). The proposed amendments mirror certain of the recent changes to the EU Margin Rules, which are covered in this briefing. The changes proposed by the Consultation are discussed below.

The Brexit effect

At present, the UK Margin Rules mirror the EU Margin Rules as they stood upon expiry of the Brexit implementation period on 31 December 2020 (IP Completion Day). Since IP Completion Day, the EU Margin Rules have been amended to implement changes that had been anticipated long before IP Completion Day, and on which the Commission had consulted several times (for more information on this, see our briefing). Had the EU Margin Rules been amended prior to IP Completion Day, it is likely that the changes would have been incorporated into the UK Margin Rules as part of the broader onshoring process. As this was not the case, in Bank of England Policy Statement 27/20, the PRA and the FCA stated their intention to consult on incorporating corresponding amendments into the UK Margin Rules.

In the Policy Statement, the PRA and the FCA also acknowledged the divergences between the UK Margin Rules, the amended EU Margin Rules, and market practice, which, rather than strictly following the current rules, instead complies with applicable regulatory guidance. In light of this, the PRA and the FCA confirmed that they would continue to follow long-term guidance provided by the European Supervisory Authorities¹ (the ESAs) that, where original deadlines and exemptions had expired, national competent authorities should enforce applicable legislation "in a proportionate manner" (i.e. exercise regulatory forbearance), pending the results of the consultation. Consequently, where the FCA and the PRA have hitherto exercised forbearance (for example, in relation to the phase-in of initial margin (IM) requirements, and the posting of variation margin (VM) in respect of physically-settled foreign exchange (FX) forwards, as discussed below), this approach can be expected to continue in the short to medium term.

Amendments to the initial margin phase-in timetable

The current timeline for the phase-in of IM requirements under the UK Margin Rules follows the original BCBS -IOSCO implementation calendar, agreed in September 2013. The original calendar comprised five "phases", with the largest and most active market participants becoming subject to IM requirements on 4 February 2017 (Phase 1), and subsequent phases starting on 1 September in that year and each consecutive year until the fifth and final phase, starting on 1 September 2020.

The BCBS²-IOSCO³ timeline has subsequently been amended, including to incorporate a further "Phase 6" implementation date and, in April 2020, to delay the remaining outstanding implementation dates by one year in response to the COVID-19 pandemic. The recommended outstanding phase-in dates are now as follows:

• Phase 5 implementation date: 1 September 2021 – applicable to entities with an average aggregate notional amount (AANA) of between €50 billion and €750 billion; and
• Phase 6 implementation date: 1 September 2022 – applicable to entities with an AANA of between €8 billion and €50 billion.

The Consultation proposes amending the UK IM phase-in timetable in line with this revised timeline.

If the proposed changes are implemented (as is expected), the UK IM phase-in timetable will also match the corresponding timetable in the EU Margin Rules, avoiding UK/EU divergence in this area.

"Opt-outs" from variation margin requirements

Under the UK Margin Rules, in-scope entities may choose to "opt out" of collecting IM in respect of physically-settled FX forwards and physically-settled FX swaps. VM, however, must be posted in respect of physically-settled FX swaps and, since January 2018, physically-settled FX forwards.

Following market consultation, in November 2017 the ESAs made a statement in which they effectively said that VM was not required for physically-settled FX forwards, and that national competent authorities should "apply their risk-based supervisory powers in their day-to-day enforcement of applicable legislation in a proportionate manner" (i.e. exercise regulatory forbearance) in this area, in substance removing the requirement to post VM in respect of physically-settled FX forwards. The reason for this was two-fold: (1) recognition of the fact that the EU Margin Rules are broader in scope than corresponding rules in other jurisdictions, which do not mandate the posting of VM for physically-settled FX forwards, and (2) at the time of the statement, EU EMIR was under review and was expected to be amended to "de-scope" these products.

The result of the EMIR review was EU Regulation 2019/834 (the EMIR Refit Regulation), which amended EU EMIR and included a Recital proposing that VM requirements in respect of both physically-settled FX forwards and physically-settled FX swaps be restricted to transactions between the most systemic counterparties. The EU Margin Rules have since been amended to incorporate this exemption but for transactions between credit institutions and investment firms subject to the EU Capital Requirements Regulation⁴ or third country equivalents thereof.

The Consultation proposes officially amending the UK Margin Rules to allow market participants to "opt out" of the VM requirements applicable to physically-settled FX forwards and physically-settled FX swaps, in the same way that they are currently able to opt out of IM requirements for these product types. As under the EU Margin Rules, the opt-out would not be available where both counterparties were credit institutions or investment firms under the EU Capital Requirements Regulation as implemented in domestic law, or third-country equivalents thereof. Consistent approaches across UK EMIR and EU EMIR on this issue would be welcomed by firms which may be obliged to comply with both.

Extension of temporary exemption from margin exchange for single-stock equity options and index options

Finally, the Consultation proposes an extension until 4 January 2024 of the temporary exemption from the requirement to exchange margin for single-stock equity options and index options. Again, this would bring the UK Margin Rules into line with the EU Margin Rules, and more closely align them with margin requirements applicable to such products in other jurisdictions, such as the US and various Asian jurisdictions.

The initial exemption was included to avoid market fragmentation and regulatory arbitrage, and to provide time to monitor global regulatory developments, given that a number of other jurisdictions do not require IM or VM to be transferred in respect of single-stock equity options and index options. The Consultation says that, although there are good reasons for such contracts to be subject to margin requirements, given that the international position has not changed materially since the original exemption was introduced, an extension to January 2024 is warranted. The extension will be welcomed by market participants, but the comments made by the PRA and the FCA in the Consultation indicate that the exemption is unlikely to be made permanent, as had been hoped by many.

No extension to derogation for intragroup transactions with a non-equivalent third-country counterparty

Unlike the recently amended EU Margin Rules, the Consultation does not propose an extension to the original temporary derogation from the requirement to exchange margin for intragroup transactions where one counterparty is located in a third country in respect of which no equivalence decision has been made⁵, which expired in January 2020. This is because the Over the Counter Derivatives, Central Counterparties and Trade Repositories (Amendment, etc., and Transitional Provision) (EU Exit) Regulations 2019 onshoring instrument implemented temporary transitional provisions for such transactions, permitting them to continue for up to three years from 1 January 2021 (subject to applicable application / notification requirements).

Confirmation of expectations where the IM amount does not exceed €50 million

In March 2019, BCBS and IOSCO confirmed that the IM framework "does not specify the application of documentation, custodial, or operational requirements if the IM amount does not exceed the framework’s €50 million IM threshold". In the Consultation, the PRA and FCA confirm that, in their view, further amendments to the UK Margin Rules are not required to clarify this (a similar conclusion was reached by the ESAs in respect of the EU Margin Rules). The practical effect of this is that counterparties whose IM obligations will not exceed €50 million will not be required to implement the operational provisions and custodial arrangements necessary to make a transfer that will never be required. However, in-scope entities are expected to "act diligently" to ensure that the relevant arrangements are in place if the threshold is exceeded. In practice, this means that parties will need to actively monitor their exposures to one another when relying on the €50 million IM threshold in order to allow time to put in place appropriate documentation and effect the operational set-up required to exchange IM if that threshold is exceeded.

The Consultation also confirms that the currency denomination (Euros) of applicable thresholds and other requirements under the UK Margin Rules will not be changed, reflecting the international nature of the OTC derivatives markets. This will be helpful for market participants, as having different currency denominations in the UK Margin Rules and the EU Margin Rules would be operationally burdensome.

Next steps

The Consultation closes on 19 May 2021. Publication of the amending FCA instrument is expected to occur on 1 July 2021.

The draft FCA instrument setting out the proposed amendments to the UK Margin Rules is contained in an Annex to the Consultation, which is accessible via this link.

Authors: Kerion Ball and Kirsty McAllister-Jones

1. The European Securities and Markets Authority (ESMA), the European Banking Authority (EBA), and the European Insurance and Occupational Pensions Authority (EIOPA)
2. The Basel Committee on Banking Supervision
3. The International Organisation of Securities Commissions
4. Regulation (EU) No 575/2013
5. Following the November 2020 partial equivalence direction made by the UK in this regard, this does not include EEA countries