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From Banking and Finance Law Daily, August 14, 2017

Capital treatment guidance provided for derivative contracts

By Andrew A. Turner, J.D.

Federal banking regulators have provided interagency guidance on the treatment of cleared settled-to-market contracts under regulatory capital rules. The guidance from the Federal Reserve Board, Federal Deposit Insurance Corporation, and the Office of the Comptroller of the Currency comes in response to recent changes for variation margin requirements in the rulebooks of certain central counterparties (OCC Bulletin 2017-27).

Under the central counterparties’ revised rulebooks, variation margin for certain cleared derivative contract netting sets is considered a settlement payment for the exposure that arises from marking the cleared derivative contract netting sets to fair value. The regulatory capital rules provide that, for a derivative contract that is structured such that on specified dates any outstanding exposure is settled and the terms are reset so that the fair value of the contract is zero, the remaining maturity equals the time until the next reset date.

For the purpose of the regulatory capital rule, the interagency guidance said that the remaining maturity on the contract equals the time until the next exchange of variation margin on the contract if a bank determines that:

  • the variation margin payment on a centrally cleared settled-to-market contract settles any outstanding exposure on the contract;
  • and the terms are reset so that fair value of the contract is zero.

In conducting its legal analysis to determine whether variation margin may be considered settlement of outstanding exposure under the regulatory capital rule, a bank should evaluate whether the transferor of the variation margin has relinquished all legal claims to the variation margin and whether the payment of variation margin constitutes settlement under the central counterparty’s rulebook and any other requirements.

MainStory: TopStory CapitalBaselAccords SecuritiesDerivatives

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