Final Phase of the UK/EU Initial Margin Requirements for Uncleared Over-the-Counter Derivatives — Action Points to Consider

As is the case with regards to initial margin requirements in the United States and other jurisdictions, the final phase of the UK and EU initial margin (IM) requirements for uncleared OTC derivatives under the European Market Infrastructure Regulation (EMIR) (the uncleared margin requirements or UMR) will take effect on 1 September 2022. Firms active in trading OTC derivatives with UK or EU dealers need to consider now whether local rules will affect them.

In the UK and EU, “Phase 6” will require the exchange of initial margin (IM) among counterparties that are either financial counterparties (FCs) or non-financial counterparties above the EMIR clearing thresholds (NFC+s), in each case, that have an aggregated average notional amount (AANA) of €8 billion or more.

Similar to the EMIR clearing obligation, FCs and NFC+s exceeding the AANA threshold will also be required to exchange IM when transacting with any third country entities that would be FCs or NFC+s if they were established in the EU or UK, as applicable. This means that UK and EU dealers will need to assess the AANA of their clients in the U.S. and other third country locations.

Firms active in trading uncleared OTC derivatives with UK and EU dealers can therefore expect to have to confirm to their dealers whether their AANA reaches the €8 billion threshold.

How do I calculate my AANA?

Under UK/EU UMR, AANA is calculated by averaging the gross notional amount of all uncleared OTC derivatives entered into by a firm and its broader “group,” as recorded on the last business day of March, April and May of the prior year. The calculation must include all non-centrally cleared “OTC Derivative Contracts” within the meaning of EMIR, including transactions that ultimately may be exempt from the requirement to exchange IM, such as certain equity option and physically settled FX products¹. The reference period to be used for evaluating whether a firm is in scope for Phase 6 is March, April, and May of 2021.

A “group” is any “parent undertaking” and its “subsidiary undertakings” within the meaning of the EU Accounting Directive (which has been transposed into UK law). Note that this approach is potentially broader than the approach under U.S. rules that simply looks at whether accounts are consolidated under generally accepted accounting principles; firms that do not need to aggregate under U.S. rules might nonetheless need to aggregate their positions under the UK/EU UMR.

UK/EU UMR offers one exception to the AANA aggregation requirements that applies to alternative investment funds (AIFs) and undertakings for the collective investment in transferable securities (UCITs) that form part of a group, but which are treated distinctly for insolvency purposes, provided that there are no guarantees or other forms of financial support provided by the other funds or the manager.

Firms familiar with the U.S. IM regime should be aware that whilst the regimes are highly similar, there is a number of distinctions in how the ANNA calculation is to be run. The table below summarises some of the key differences.

	U.S. Rules2 AANA Criteria (to be calculated in US$)	UK Rules and EU Rules AANA Criteria (to be calculated in €)
Phase 6 (1 September, 2022) Threshold	Commodity Futures Trading Commission (CFTC) Rules: US$8 billion in month-end average gross notional of all in-scope contracts calculated for the applicable Phase 6 reference period (see below). PR Rules: US$8 billion in daily average gross notional of all in-scope contracts calculated for the applicable Phase 6 reference period (see below).	€8 billion in month-end average gross notional of all in-scope contracts calculated for the applicable Phase 6 reference period (see below).
Phase 6 Reference Period for Calculation of AANA	Commodity Futures Trading Commission (CFTC) Rules: March, April and May of 2022 as recorded on THE LAST business day of each month. PR Rules: June, July, and August of 2021 as recorded on EACH business day of each month.	March, April and May of 2022 as recorded on THE LAST business day of each month.
Product Type	All non-centrally cleared CFTC-regulated “swaps,”3 Securities and Exchange Commission -regulated “security-based swaps,”4 and physically-settled foreign exchange (FX) forwards and FX swaps. This definition excludes equity options.	All non-centrally cleared “OTC derivative contracts” within the meaning of EMIR, including both cash and physically-settled FX forwards and FX swaps.   This definition includes equity options.
Execution Venue of Contract	Include all in-scope contracts, regardless of the execution venue — whether executed bilaterally or on a swap execution facility or other execution venue or trading facility.	Include all in-scope contracts that are executed bilaterally and any contracts executed on any venue/trading facility which is not includedin the relevant list published by the European Securities Markets Authority.

What happens if my AANA exceeds the threshold?

Firms that exceed the €8 billion threshold will need to discuss IM arrangements with their dealers and custodians as soon as possible.

Similar to the U.S. rules, the UMR provide for an unsecured exposure threshold (of up to a maximum of €50 million) that OTC derivatives counterparties may use where both counterparties exceed the relevant AANA threshold. This means that even where a firm or its group exceeds the relevant AANA threshold, the firm could agree with its dealer that IM would not be exchanged unless and until the agreed exposure threshold is reached.

Note, however, that dealers may require formal threshold monitoring arrangements even where the maximum exposure threshold has not been reached, with contractual arrangements for the exchange of IM required once a negotiated threshold is reached.

Where contractual arrangements are required, firms will need to execute tailored collateral agreements with their dealers. As the UMR require IM to be segregated, arrangements will also need to be put in place with a custodian who will hold the IM in a dedicated account. The following timeline shows the steps generally required for implementing IM exchange: