RBI issues guidelines to market participants regarding exchange of variation margin (VM) for NCCDs

In today’s (June 8, 2022) statement of development and regulatory policies the Reserve Bank of India issued guidelines to market participants regarding the exchange of variation margin (VM) for non-centrally cleared derivatives (NCCDs).

Derivatives are financial instruments whose value is derived from other underlying assets. There are mainly four types of derivative contracts such as (i) options, (ii) swaps, (iii & iv) futures and forwards. Non-centrally cleared derivatives (NCCDs) mean permitted derivatives that are not cleared by a central counterparty. Variation Margin means the collateral that is collected or paid to reflect the current mark-to-market exposure resulting from changes in the market value of a derivative contract. The initial margin is the minimum balance an entity needs to have in its account to open a position. Variation Margin is the unrealised profit (or loss) on open positions or transactions. The BCBS-IOSCO guidelines (BCBS-IOSCO, 2015) define the IM requirement as an amount that “covers potential future exposure for the expected time between the last VM exchange and the liquidation of positions on the default of counterparty”. Netting agreement means an arrangement where, upon default or early termination by a party to the arrangement, the parties to the arrangement are contractually obligated to net the mark-to-market values of all NCCDs that are the subject of the arrangement, into a single net payable or receivable.

“Well-established variation and initial margining requirements for over-the-counter (OTC) NCCD transactions contribute to financial stability and are a key component of the post-crisis G20 recommendations for these markets. With the objective of strengthening the resilience of the OTC derivatives market, the Reserve Bank had earlier issued a discussion paper to implement global practices related to margin requirements for OTC derivatives. Against this backdrop, Directions on the exchange of Variation Margin (VM) for NCCDs were issued on June 1, 2022. Draft Directions on the exchange of Initial Margin (IM) for NCCDs are being issued for public feedback separately” RBI said in the RBI’s statements of regulatory and development policies of June 8, 2022.

The Bilateral Netting of Qualified Financial Contracts Bill, 2020 (Netting Bill) was passed in September 2020 in both the houses of the Indian Parliament. The Bill covers over-the-counter derivatives contracts that are entered into on a bilateral basis outside the clearing system. Bilateral contracts constitute 40 per cent of total financial contracts while multilateral contracts constitute 60 per cent, she added. She further said that based on the data collected by 31 private, public and foreign banks, the amount of bank capital that went unutilised due the absence of this bill, from FY17-FY20 stood at Rs 2.14 lakh crore. The promulgation of the Act for Bilateral Netting of Qualified Financial Contracts, 2020, ensured legal recognition for bilateral netting of an OTC derivative transaction and has put in place a significant enabler for efficient margining.

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