On August 25, 2023, the Financial Supervisory Service (the “FSS”) issued a press release (the relevant documents are available in Korean, Link) (the “Press Release”) for the publication of the annual update of the “Guidelines on Margin Requirements for Non-Centrally Cleared OTC Derivatives Transactions” (the “Margin Guidelines”). Each year, together with the Press Release, the FSS announces those Korean financial companies that will be subject to margin requirements under the Margin Guidelines (“Margin Requirements”) for one year from September 1 of that year based on the Average Aggregated Notional Amount of non-centrally cleared OTC derivatives traded by each financial company as of the end of March, April and May of each year (the “AANA”). This year’s Press Release is noteworthy in that Chinese banks (“PRC Banks”) are now expressly included as being subject to the Margin Requirements.
PRC Banks Entering the Scope of the Margin Guidelines
Until recently, PRC Banks have been exempted from the Margin Requirements. The rationale for the exemption is based on the sections under the Margin Guidelines stating that “if the counterparty is a financial institution (including branches thereof) from a country where entry into a netting agreement is prohibited or the enforcement of security interest under the insolvency or bankruptcy proceedings of the subject foreign financial institution is uncertain, the exchange of initial margin (“IM”) or variation margin (“VM”) may be exempted” (Sections III.2.1.3 and III.3.1.3 of the Margin Guidelines).
The Futures and Derivatives Act of the People’s Republic of China (the relevant documents are available in Korean, Link) was passed at the 34th meeting of the Standing Committee of the 13th National People’s Congress on April 20, 2022 and took effect on August 1 of the same year. As a result, the People’s Republic of China is now classified as a country in which entry into netting agreements is permitted and the enforcement of security interest in insolvency and bankruptcy proceedings is possible. Consequently, PRC Banks are now subject to the Margin Guidelines.
In line with the foregoing, the FSS identified in the Press Release two PRC Banks (i.e., the Industrial and Commercial Bank of China and China Construction Bank) as financial institutions subject to the IM requirements for the period from September, 2023 to August, 2024. Separately, it is noted that while the Press Release does not specifically list financial institutions subject to the exchange of VM in accordance with the Margin Guidelines, financial companies with an AANA of KRW 3 trillion or more are subject to the VM requirements. As a result, PRC Banks may also be subject to the VM requirements.
Matters to Note From the Application of the Margin Guidelines to PRC Banks
A financial institution becoming newly subject to the IM requirement must exchange IM for non-centrally cleared OTC derivatives transactions entered into with counterparties from September 1, 2023 onwards. However, according to the Margin Guidelines, the threshold for the application of the IM requirement is KRW 65 billion. Therefore we advise affected parties to take this threshold for exemption into consideration and plan in advance for entry into IM CSAs with counterparties.
On the other hand, financial institutions becoming newly subject to the VM requirement are granted a grace period of six months from the date of application of the VM requirement to familiarize themselves with, and prepare for, compliance of the Margin Guidelines (Section II.3.2.4 of the Margin Guidelines). Hence, financial institutions in question will be subject to the VM requirement under the Margin Guidelines on new transactions executed from April 1, 2024 (that is, six months after the effective date of the Margin Guidelines) onwards. Those financial institutions newly coming into the scope of application should therefore utilize this period to execute VM CSAs and to establish an internal collateral management system.
Financial institutions are obligated to inform the counterparty as to whether it is subject to the Margin Guidelines (footnote 20 of the Margin Guidelines). As such, the firms that are coming into the scope of application under the Margin Guidelines should take measures to duly inform their counterparties of this development.
Meanwhile, if a PRC Bank (including its Seoul branch) executes a CSA with another foreign bank (including its Seoul branch) and exchanges margin in compliance with the margin requirements of another relevant jurisdiction adopted in accordance with the BCBS-IOCSCO Margin Requirements for Non-centrally Cleared Derivatives (Link), such parties would not be required to comply with the Margin Requirements as “substituted compliance” is recognized under the Margin Guidelines (Section IV.2 of the Margin Guidelines).
On the other hand, if a PRC Bank (including its Seoul Branch) engages in non-centrally cleared OTC derivatives transactions with a Korean financial company, including local subsidiaries of foreign financial companies, “substituted compliance” for such non-centerally cleared OTC derivatives transactions are not applicable and compliance with the Margin Guidelines would be required.