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EMIR: Proposal for physically settled foreign exchange forward transactions to fall outside scope of variation margin requirements

EMIR: Proposal for physically settled foreign exchange forward transactions to fall outside scope of variation margin requirements

  • Europe
  • Financial services and markets regulation - EMIR

27-11-2017

The European Commission has published proposed amendments to EMIR which include a proposal for physically settled foreign exchange forward transactions to fall outside the scope of the variation margin requirements that apply to uncleared OTC derivatives transactions for certain entities.

Variation margin for physically settled foreign exchange forward transactions

Physically settled foreign exchange forward transactions are subject to a transitional exemption from the requirement to exchange variation margin under the detailed EU rules regarding margin for uncleared OTC derivatives transactions[1] (the “Margin RTS”) which supplement the European Market Infrastructure Regulation[2] (“EMIR”). This exemption expires on 3 January 2018.

Following 3 January 2018 entities that are subject to the Margin RTS and enter into physically settled foreign exchange forward transactions will be required to exchange variation margin in respect of those transactions.

Background to EMIR review and proposed amendments  

Between 2015 and 2016 the European Commission carried out an assessment of EMIR. This assessment included a public consultation, the publication of a general report on EMIR and the publication of an impact assessment on possible amendments to EMIR.

In May 2017 the European Commission proposed amendments to EMIR in the form of a draft Regulation. A revised version of the draft Regulation was published by the European Commission in June 2017.

On 15 November 2015, the European Commission published a further revised version of the proposed Regulation[3] (the “Proposed Regulation”). The Proposed Regulation includes an exemption in respect of certain physically settled foreign exchange swaps and forwards.

Changes to variation margin for physically settled foreign exchange forward transactions under Proposed Regulation 

The EU is the only jurisdiction which includes physically settled foreign exchange forward transactions within the scope of its variation margin regime. Physically settled foreign exchange forward transactions are excluded from the variation margin regimes in other jurisdictions.[4] Industry bodies and market participants had previously argued that this might affect the ability of EU firms to hedge and might also undermine the competitiveness on EU financial institutions.

In response to those concerns, the Proposed Regulation notes that it is appropriate to restrict the mandatory exchange of variation margin on physically settled foreign exchange forwards to transactions between the most systemically important counterparties in order to limit the build-up of systemic risk. Under the Proposed Regulation, physically settled foreign exchange forwards will only be subject to exchange of variation margin for transactions concluded between credit institutions. 

Timing and impact on EU entities

There is currently no fixed timeline for the Proposed Regulation to enter into force and the Proposed Regulation may be subject to further amendments. In scope EU entities that enter into physically settled foreign exchange transactions should therefore ensure that they are in a positon to comply with the variation margin requirements on 3 January 2018 but should monitor the position ahead of 3 January 2018 in case the requirements change.

In particular, it is noted that the European Supervisory Authorities (“ESAs”) have recognised the challenges that certain in-scope entities face in order to established exchange of variation arrangements by the 3 January 2018 deadline. The Boards of the ESAs are currently undertaking a review of the Margin RTS and intend to develop draft amendments that align the treatment of variation margin for physically-settled foreign exchange forwards with the supervisory guidance applicable in other key jurisdictions. Until any such amendments are implemented, the ESAs expect competent authorities to generally apply their risk-based supervisory powers in their day-to-day enforcement of applicable legislation in a proportionate manner.


[1] Commission Delegated Regulation (EU) 2016/2251 of 4 October 2016 supplementing Regulation (EU) No 648/2012 of the European Parliament and of the Council on OTC derivatives, central counterparties and trade repositories with regard to regulatory technical standards for risk-mitigation techniques for OTC derivative contracts not cleared by a central counterparty.

[2] Regulation (EU) No 648/2012 of the European Parliament and of the Council of 4 July 2012 on OTC derivatives. 

[3] Proposal for a Regulation of the European Parliament and of the Council amending Regulation (EU) No 648/2012 as regards the clearing obligation, the suspension of the clearing obligation, the reporting requirements, the risk-mitigation techniques for OTC derivatives contracts not cleared by a central counterparty, the registration and supervision of trade repositories and the requirements for trade repositories.

[4] In particular, the United States, Japan, Canada, Singapore, Australia, Switzerland, Hong Kong and South Korea.

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