RBI brings out new norms for safety settlement of non-centrally cleared OTC derivatives

The Reserve Bank of India (RBI) on Wednesday issued guidelines to market participants regarding exchange of variation margin (VM) for non-centrally cleared derivatives (NCCDs).

RBI issued the Master Directions covering NCCDs -- foreign exchange derivative contracts, interest rate derivative contracts, credit derivative contracts and any other NCCD as may be specified by the central bank -- to improve safety of settlement of over-the-counter (OTC) derivatives that are not centrally cleared.

NCCDs mean derivative contracts whose settlement is not guaranteed 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.

Domestic Covered Entities

RBI said a Domestic Covered Entity shall exchange Variation Margin with a counterparty to an NCCD transaction if the counterparty is a Domestic Covered Entity or a Foreign Covered Entity.

A Domestic Covered Entity shall put in place appropriate processes for ascertaining whether a counterparty to an NCCD transaction is a Domestic Covered Entity or a Foreign Covered Entity. For this purpose, Domestic Covered Entities may, inter alia, rely on a declaration from the counterparties.

RBI said the provisions of these directions will not apply to physically-settled foreign exchange forward and physically-settled foreign exchange swap contracts. However, Domestic Covered Entities are expected to appropriately manage the risks associated with such transactions

Further, the provisions of these directions shall not be applicable to an NCCD transaction in which one of the counterparties is Government of India and State Governments; a foreign sovereign, a central bank, Bank for International Settlements; and multilateral development banks.

Domestic Covered Entities under these directions include 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 ₹25,000 crore and above, on a consolidated group-wide basis; and other resident entities having an AANA of outstanding NCCDs of ₹60,000 crore and above, on a consolidated group wide basis.

Foreign Covered Entities

Foreign Covered Entities under these directions include 1) non-resident financial entities having an AANA of outstanding NCCDs of $3 billion and above, on a consolidated group-wide basis; and other non-resident entities having an AANA of outstanding NCCDs of $8 billion and above, on a consolidated group-wide basis.

Variation Margin between two Domestic Covered Entities shall be exchanged using collateral such as Indian currency, debt securities issued by Government of India and State Governments; and Rupee bonds issued by persons resident in India (which are listed on a recognised stock exchange in India; and assigned a credit rating of AAA by a rating agency).

Variation Margin between a Domestic Covered Entity and a Foreign Covered Entity shall be exchanged using collateral mentioned above and 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.

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