Initial Margin – November 2021 Update

It has been a few months since our last update in July 2021 on the implementation of initial margin (“IM”). We set out below a few notable recent developments which market participants should be aware of:

• Mainland Chinese counterparties: With the revised draft of the PRC Futures and Derivatives Law having been submitted to the Standing Committee of the National People’s Congress for second reading, it is anticipated that, once the law has been passed, close-out netting provisions in a derivatives master agreement duly filed with the regulators in accordance with the law will be given legal protection under PRC law. Currently, the market has been operating on the basis that mainland China is a non-netting jurisdiction. The passing of the PRC Futures and Derivatives Law will have a significant impact on the derivatives market.  
  
  Although mainland China has not implemented its own margin requirements for non-centrally cleared derivatives, mainland Chinese banks trading with foreign counterparties subject to margin requirements in their own jurisdictions may have to exchange regulatory margin with these foreign counterparties if the relevant conditions are met. Currently, some foreign counterparties have been relying on exemptions available when trading with counterparties in non-netting jurisdictions. With this major development in PRC law to come, market participants are advised to watch this space closely as this will impact on how they trade derivatives with mainland Chinese counterparties in both the onshore and offshore markets.
• SEC margin rules: ISDA recently published the following three SEC IM Supplements: (1) SEC IM Supplement (Third Party Segregation), (2) SEC IM Supplement ([Omnibus][No] Segregation) and (3) SEC IM Supplement (Alternative Compliance Mechanism).  Each of the SEC IM Supplements is designed as a supplemental agreement under which the parties agree to modify, in the case of the SEC IM Supplement (Third Party Segregation) and the SEC IM Supplement (Alternative Compliance Mechanism), one or more of their ISDA published next generation initial margin documentation or, in the case of the SEC IM Supplement (Alternative Compliance Mechanism), their ISDA published variation margin credit support annex, as applicable, for compliance with the initial margin regulations adopted by the U.S. Securities and Exchange Commission.  Non-bank security-based swap dealers registered with the U.S. Securities and Exchange Commission must comply with such initial margin regulations.  Therefore, parties who trade security-based swaps with non-bank security-based swap dealers may need to update their existing documentation using one of these SEC IM Supplements.  
• Publication of KSD ACA: The Korea Securities Depository has published a form of initial margin account control agreement for use by the market. In addition to the recent publication by ISDA of the 2021 Korean Law Security Agreement for Initial Margin (IM) and the KRW Collateral (IM) Addendum for use with the ISDA 2019 Collateral Transfer Agreement for Initial Margin (IM), counterparties wishing to use Korean collateral for IM or trade with Korean counterparties should note these recent publications and consider any repapering exercise required.
• Completion of Phase 5 implementation of IM requirements and lessons learned: Counterparties in scope for Phase 5 IM requirements have started exchanging IM with its in scope counterparties from 1 September 2021.  We set out below a few lessons learned for those counterparties who are in scope for Phase 6 (with a deadline of 1 September 2022) so as to ease the implementation process:
  
  > Timing: you will need to engage custodians as part of the IM implementation so do build this into the timetable.  Most custodians have cut-off dates for on-boarding new clients which can be as early as March or April of that year. Negotiations can take as long as 6 months to complete so do start early. 
  
  > Counterparty prioritisation: given the costs involved with IM, it may be necessary to cut down on the counterparty pairs you have as a practical matter.  Consider prioritising the counterparty pairs that are key to your derivatives trading.
  
  > Eligible collateral: you may wish to sort out your eligible collateral early: the collateral requirements of each jurisdiction may be slightly different and can be challenging to piece through.
  
  > Don’t forget to register your IM security agreements under the rules of the relevant jurisdiction(s) as this may affect the validity of the security created.
  
  > In some jurisdictions (e.g. Hong Kong), requirements for risk mitigation standards (RMS) may kick in at the same time as IM for certain counterparties.  It may be necessary to negotiate RMS amendment agreement at the same time as IM implementation.

Linklaters acted as drafting counsel to ISDA on the "Next Generation" IM documentation and has developed for ISDA an online negotiation tool for IM - “ISDA Create”. We have also been working with numerous Asian clients in this area, and we would be happy to assist you with your IM implementation efforts. For a list of FAQs, click "read more" below.