European Council changes tack on FX Variation Margin

Change could be afoot in the FX margining requirements under EMIR.  On 15th November, the Council of the European Union published a proposed amendment to the text.  The text includes the following on page 30 of the document:

“Physically settled foreign exchanged forwards shall not be subject to initial margins exchanges and shall only be subject to exchange of variation margins for transactions concluded between credit institutions authorised in accordance with Directive 2006/48/EC.”

Benefits to investors, if agreed

This still has to be approved through the machinery of the EU.  There is practically no chance of its approval before the implementation date of January 1st 2018, but we see this as a very positive step by the EU.  The decision will help investors to avoid circumstances in which portfolios become underinvested due to cash being required to meet losses on hedges.  The correct investment decision in country allocation terms becomes a portfolio drag if the rule stays in place.  Keeping the rule in place assumes that asset managers have cash at hand in order to meet the FX Variation Margin requirements.  This is simply not the case unless the manager is either permitted to borrow, or assets are sold to in order to retain a cash buffer.  This leads to underinvestment, and hence underperformance.  Every penny counts so constraining managers from full investment makes no sense.  In addition, buy-side use of FX for hedges is in itself a risk-reducing strategy, so reducing the attractiveness of hedging is also somewhat questionable.

If approved, deliverable FX forwards executed buy side clients would no longer post variation margins but the rule does not apply to non-deliverable forwards, which still require margins to be posted.  We shall endeavour to keep you posted on what happens next.