Cleared derivatives are generally characterized as being either “collateralized-to-market” (“CTM”) or “settled-to-market” (“STM”) in connection with the mitigation of counterparty credit risk resulting from movements in mark-to-market value. Under the CTM approach, transfers of variation margin are characterized as daily “collateral” transfers, with the transferring party having a right to reclaim the collateral (a financial asset) and the receiving party having the obligation to return the collateral (a financial liability), as well as a legal right to liquidate the collateral in the event of a close-out.
Under the STM approach, variation margin reflects daily “gain” to the receiving party that is actually settled. Despite the settlement of the gain on a daily basis, the derivative’s underlying economic terms remain the same (in other words, there is no amendment or recouponing of the trade). However, unlike the CTM approach, variation margin transferred is not regarded as pledged collateral securing obligations between the parties. Rather, variation margin is deemed to “settle outstanding exposure” between them (with no right to reclaim or obligation to return the variation margin) and, after that settlement, the mark-to-market between the parties resets to zero. READ MORE →
Beginning on December 15, 2017, amendments approved by the Securities and Exchange Commission (“SEC”) last year to FINRA Rule 4210 will require U.S. registered broker-dealers to collect (but not post) daily variation margin and, in some cases, initial margin, from their customers on specified transactions.
These new margin requirements apply to “Covered Agency Transactions,” which include: (i) “to-be-announced” (or “TBA”) transactions on mortgage-backed securities (“MBS”) and specified pool transactions for which the settlement date is more than one business day after the trade date; and (ii) U.S. agency collateralized mortgage obligations for which the settlement date is more than three business days after the trade date. TBA transactions account for the vast majority of trading in the sizable agency MBS market.READ MORE →