Response to second Joint Consultation on draft RTS on risk-mitigation techniques for OTC-derivative contracts not cleared by a CCP
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i) Calculating the impact of stressed FX moves on the underlying portfolio and posting sufficient collateral to cover any losses at the appropriate quantile.
ii) Directly hedging the FX risk of the underlying OTC portfolio by posting collateral in the appropriate currency.
This second alternative has the advantage that it provides a direct hedge against losses that is model independent. Moreover, to the extent that the underlying portfolio has exposure to multiple currencies, it naturally encourages diversification of collateral.
If haircuts are imposed that dis-incentivise the posting of collateral in multiple currencies, economically rational hedging may be discouraged, worsening outcomes.
We ask that the wording allow the offset of FX risks between collateral and portfolio before haircuts against the termination currency are calculated.
Respondents are invited to comment on the proposal in this section concerning the timing of calculation, call and delivery of initial and variation margins.
Non-ApplicableRespondent are invited to provide comments on whether the draft RTS might produce unintended consequence concerning the design or the implementation of initial margin models.
NetOTC welcomes the proposed change – the additional flexibility should allow a more straightforward initial margin calculation while still preserving resilience to post-default stress.Respondents are invited to comment on whether the requirements of this section concerning the concentration limits address the concerns expressed on the previous proposal.
Non-ApplicableRespondent to this consultation are invited to highlight their concerns on the requirements on trading relationship documentation.
Non-ApplicableRespondents are invited to comment on the requirements of this section concerning the legal basis for the compliance.
Non-ApplicableDoes this approach address the concerns on the use of cash for initial margin?
Non-ApplicableRespondents are invited to comment on the requirements of this section concerning treatment of FX mismatch between collateral and OTC derivatives.
While we understand the simplicity of a single “termination currency” approach, we are concerned about dis-incentivising real hedging of currency risk in the underlying OTC portfolio. To the extent that there are FX risk exposures in the underlying portfolio, there are two straightforward approaches to protecting against FX losses arising from the default of a counterparty:i) Calculating the impact of stressed FX moves on the underlying portfolio and posting sufficient collateral to cover any losses at the appropriate quantile.
ii) Directly hedging the FX risk of the underlying OTC portfolio by posting collateral in the appropriate currency.
This second alternative has the advantage that it provides a direct hedge against losses that is model independent. Moreover, to the extent that the underlying portfolio has exposure to multiple currencies, it naturally encourages diversification of collateral.
If haircuts are imposed that dis-incentivise the posting of collateral in multiple currencies, economically rational hedging may be discouraged, worsening outcomes.
We ask that the wording allow the offset of FX risks between collateral and portfolio before haircuts against the termination currency are calculated.
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