Margining for Non-Centrally Cleared OTC Derivatives

Reserve Bank of India (RBI) has issued directions on margining for non-centrally cleared over-the-counter (OTC) derivatives.

What is derivative?

Derivative means a financial contract, to be settled at a future date, whose value is derived from one or more financial, or non-financial variables.

What are over-the-counter (OTC) derivatives?

Over-the-counter (OTC) derivatives are the contracts that are traded directly between two eligible parties, with or without the use of an intermediary and without going through an exchange.

What are non-centrally cleared derivatives (NCCDs)?

Non-centrally cleared derivatives (NCCDs) mean derivative contracts whose settlement is not guaranteed by a central counterparty.

Central counterparty means an entity that interposes itself between counterparties to contracts traded in one or more financial markets, becoming the buyer to every seller and the seller to every buyer and thereby ensuring the performance of open contracts.

From when shall the directions on margining for non-centrally cleared OTC derivatives be applicable?

The directions on margining for non-centrally cleared OTC derivatives shall come into force on November 08, 2024.

To which contacts shall the directions be applicable?

The directions shall apply to the following contracts, which are entered into on or after November 08, 2024.

• Non-centrally cleared foreign exchange derivative contracts 
• Non-centrally cleared interest rate derivative contracts 
• Non-centrally cleared credit derivative contracts 

What is margin?

A margin is a collateral that the holder of a financial instrument has to deposit to cover the risk of their counterparty.

Initial Margin	Variation Margin
Initial Margin means the collateral that is collected to cover the potential future exposure that could arise from future changes in the market value of a derivative contract during the time it takes to close out and / or replace the position in the event of a counterparty default.	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.
Initial Margin shall be calculated at the outset of a transaction and thereafter on a regular and consistent basis upon changes in the potential future exposure, including, but not limited to, when trades are added to or subtracted from the portfolio, on occurrence of a significant market disruption, and when the Initial Margin model (if applicable) is recalibrated.	Variation Margin shall fully collateralise to market or settle to market, the mark-to-market exposure of an NCCD contract. In the event that the exposures cannot be marked-to-market, a pre-agreed alternative process or fallback mechanism, shall be used for the purpose of calculation of Variation Margin.
Initial Margin shall be recalculated within a period not exceeding 10 working days.	Variation Margin shall be calculated on a daily basis.
The amount of Initial Margin shall be calculated by reference to either – Standardised approach Quantitative portfolio margin model (model approach) Covered Entities may choose between the standardised approach and the model approach. RBI may direct a Covered Entity to calculate Initial Margin using the standardised approach, if RBI is satisfied that it is necessary or expedient to do so.	Variation Margin shall be calculated on an aggregate net basis, across all NCCD contracts that are executed under a single, legally enforceable netting agreement.

What is Collateralise to Market and Settle to Market?

• Collateralise to Market – Collateralise to market means an approach to the exchange of Variation Margin wherein the exchanged margin is characterised as collateral to secure the current mark-to-market exposure between the parties to a derivative contract.
• Settle to Market – Settle to market means an approach to the exchange of Variation Margin wherein the exchanged margin is deemed to settle the current mark-to-market exposure between the parties to a derivative contract, with no right to reclaim and no obligation to return the Variation Margin. After the settlement, the mark-to-market exposure between the parties is reset to zero.

Which are covered entities?

The following are the covered entities for the exchange of initial / variation margin –

Domestic Covered Entities – Initial Margin (IM)	Domestic Covered Entities – Variation Margin (VM)
Entities regulated by a financial sector regulator (including branches of foreign banks operating in India) and having an Average Aggregate Notional Amount (AANA) of outstanding NCCDs of ₹60,000 crore and above, on a consolidated group wide basis.	Entities regulated by a financial sector regulator (including branches of foreign banks operating in India) and having an AANA of outstanding NCCDs of ₹25,000 crore and above, on a consolidated group wide basis. Other resident entities having an AANA of outstanding NCCDs of ₹60,000 crore and above, on a consolidated group wide basis.
Foreign Covered Entities – Initial Margin (IM)	Foreign Covered Entities – Variation Margin (VM)
Non-resident financial entities having an AANA of outstanding NCCDs of USD 8 billion and above, on a consolidated group wide basis.	Non-resident financial entities having an AANA of outstanding NCCDs of USD 3 billion and above, on a consolidated group wide basis. Other non-resident entities having an AANA of outstanding NCCDs of USD 8 billion and above, on a consolidated group wide basis.

Who are financial sector regulators for the purpose of the directions?

Financial sector regulator refers to RBI, Securities and Exchange Board of India (SEBI), Insurance Regulatory and Development Authority of India (IRDAI) and Pension Fund Regulatory and Development Authority (PFRDA).

What is Average Aggregate Notional Amount (AANA)?

• AANA of outstanding NCCDs shall be calculated as the simple average of the total notional amount of outstanding NCCDs as at the end of March, April and May of a year. 
• AANA for a year shall be used for recognition of Domestic Covered Entities and Foreign Covered Entities for a one-year period from September 1 of that year to August 31 of the next year.
• AANA calculation shall include all NCCD contracts of the consolidated group, including those outside the scope of the directions, but exclude intra-group transactions.

Who can be the counterparties?

A Covered Entity shall exchange initial / variation with a counterparty to an NCCD transaction as below –

Covered Entity	Exchange of	Counterparty
Domestic Covered Entity – IM	Initial Margin	Domestic Covered Entity – IM or Foreign Covered Entity – IM
Domestic Covered Entity – VM	Variation Margin	Domestic Covered Entity – VM or Foreign Covered Entity – VM

The directions shall not be applicable to an NCCD transaction in which one of the counterparties is any of the following entities –

• Government of India and State Governments
• Foreign Sovereign
• Central Bank
• Bank for International Settlements (BIS)
• Multilateral Development Banks (MDBs)

How shall margins be exchanged?

• Initial Margin shall be exchanged on a gross basis without any netting of Initial Margin amounts owed by the two counterparties, across all NCCD contracts that are executed under a single, legally enforceable netting agreement.
• Variation Margin shall be exchanged on an aggregate net basis, across all NCCD contracts that are executed under a single, legally enforceable netting agreement.
• A threshold amount, not exceeding ₹450 crore, may be applied for the exchange of Initial Margin. 
• A minimum transfer amount (MTA), not exceeding ₹4.5 crore, may be applied for the exchange of Initial Margin and Variation Margin combined. 
• Initial Margin and Variation Margin shall be called and exchanged at the earliest time possible after the transaction date (T) or margin recalculation date (R), but no later than 3 local business days from the transaction date (T+3) or margin recalculation date (R+3).

What are eligible collaterals for exchange of margin?

The margin between two covered entities shall be exchanged using the following collaterals –

Margin	Initial Margin	Variation Margin
Covered Entities	Between two Domestic Covered Entities – IM	Between two Domestic Covered Entities – VM
Eligible collateral	Indian Currency Debt securities issued by Government of India and State Governments	Indian Currency Debt securities issued by Government of India and State Governments Rupee bonds issued by persons resident in India which are – Listed on a recognised stock exchange in India Assigned a credit rating of AAA by a rating agency registered with SEBI Certificate of Deposits Commercial Papers which are assigned a minimum credit rating of A1 by a rating agency registered with SEBI
Margin	Initial Margin	Variation Margin
Covered Entities	Between Domestic Covered Entity – IM and Foreign Covered Entity – IM	Between Domestic Covered Entity – VM and Foreign Covered Entity – VM
Eligible collateral	Indian currency Freely convertible foreign currency Debt securities issued by Government of India and State Governments Debt securities issued by foreign sovereigns with a credit rating of AA- and above issued by S&P Global Ratings / Fitch Ratings or Aa3 and above issued by Moody’s Investors Service	Indian currency Freely convertible foreign currency Debt securities issued by Government of India and State Governments Debt securities issued by foreign sovereigns with a credit rating of AA- and above issued by S&P Global Ratings / Fitch Ratings or Aa3 and above issued by Moody’s Investors Service Rupee bonds issued by persons resident in India which are – Listed on a recognised stock exchange in India Assigned a credit rating of AAA by a rating agency registered with SEBI Certificate of Deposits Commercial Papers which are assigned a minimum credit rating of A1 by a rating agency registered with SEBI
If different ratings are accorded by two or more credit rating agencies, then the lowest rating shall be reckoned.

What are other directions?

• The directions shall not be applicable to an NCCD transaction between entities belonging to the same consolidated group.
• An entity, on being classified as a Covered Entity, shall be required to exchange Initial Margin and Variation Margin with other covered entities, only for NCCD transactions undertaken after recognition of the entity as a Covered Entity.
• A Covered Entity, on ceasing to be classified as a Covered Entity, may choose, not to exchange margin for its NCCD transactions, including outstanding NCCD transactions, from the date on which it ceases to be recognised as a Covered Entity.
• Scheduled Commercial Banks and Clearing Corporation of India Limited (CCIL) shall be eligible to act as a collateral service provider for Initial Margin posted in India.
• Eligible collateral that was originally posted or collected may be substituted provided the value of the substituted collateral, after the application of risk-sensitive haircuts, is sufficient to meet the margin requirement.

References

Reserve Bank of India. (2024, May 08). 'Master Direction – Reserve Bank of India (Margining for Non-Centrally Cleared OTC Derivatives) Directions, 2024'. Retrieved from https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=12682&Mode=0

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