variation margin — is collateral that is collected or paid to reflect the current mark-to-market exposure resulting from changes in the market value of a derivative.

initial margin — is collateral that is collected to cover the potential future exposure that could arise from future changes in the market value of a derivative over the close-out period in the event of a counterparty default;

covered counterparty — is an entity that is a financial institution with the following exclusions:

threshold — is the amount specified in a margin agreement that defines the level of exposure above which margin will be posted. The threshold represents the amount of uncollateralised exposure allowed under the margin agreement;

APRA means the Australian Prudential Regulation Authority.

the prudential standard means Prudential Standard CPS 226 Margining and risk mitigation for non-centrally cleared derivatives.

RSE — is a ‘registrable superannuation entity’ as defined in the SIS Act;

Level 2 as defined in APS 001; or

For the purposes of this Prudential Standard, an ‘RSE licensee’s business operations’ includes all activities as an RSE licensee (including the activities of each RSE of which it is the licensee), and all other activities of the RSE licensee to the extent that they are relevant to, or may impact on, its activities as an RSE licensee.

ADI has the meaning given in section 5 of the Banking Act.

authorised banking NOHC has the meaning given to the expression authorised NOHC in section 5 of the Banking Act.

general insurer has the meaning given in section 11 of the Insurance Act.

authorised insurance NOHC has the meaning given to the expression authorised NOHC in subsection 3(1) of the Insurance Act.

life company has the meaning given in the Schedule to the Life Insurance Act.

friendly society has the meaning given in section 16C of the Life Insurance Act.

registered life NOHC has the meaning given to the expression registered NOHC in the Schedule to the Life Insurance Act.

Head of a Level 2 group — is each of the following:

Level 2 group — means the entities that comprise:

For the avoidance of doubt, a reference to an ‘APRA covered entity’ in this Prudential Standard is to be read, for the purposes of paragraph 4 of this Prudential Standard, as a reference to the entity and also all members of an APRA covered entity’s Level 2 group that are covered counterparties.

The calculation of the notional amounts must include physically settled foreign exchange forwards and swaps.

Subregulation 6(2) of the Payment Systems and Netting Regulations 2001 identifies obligations that are not eligible obligations in relation to a close out netting contract. The arrangements mentioned include credit facilities, reciprocal purchase agreements (otherwise known as repurchase agreements), sell buyback arrangements, securities loan arrangements, contracts of insurance and managed investment schemes.

For clarity, the definition does not apply where a portfolio manager is acting as an agent.

Refer to subsection 11AF(2) of the Banking Act, subsection 32(3D) of the Insurance Act, subsection 230A(4) of the Life Insurance Act and subsection 34C(5) of the SIS Act.

non-centrally cleared derivative — is a derivative that is not cleared by a CCP. This does not include exchange traded derivatives, securities financing transactions and indirectly cleared derivatives that are intermediated through a clearing member on behalf of a non-member client where the client is subject to the margin requirements of the CCP, or where the client provides margin consistent with the CCP’s margin requirements;

Refer to paragraphs 59 to 63 of this Prudential Standard for the treatment of intra-group transactions.

margining period — is the period of time during which margin must be exchanged for all new transactions entered into within that period (see Tables 1 and 2);

margining group — is a group, comprising one or more entities, within the meaning of Australian Accounting Standard AASB 10 Consolidated Financial Statements; however, an APRA covered entity may elect to apply equivalent foreign accounting standards that apply to the consolidated financial statements of the APRA covered entity or covered counterparty, as relevant;

aggregate month-end average notional amount — is the simple average of the total notional amount[3] of outstanding non-centrally cleared derivative transactions as at the end of each month in the reference period. The total notional amount is the aggregate of all outstanding non-centrally cleared derivative transactions across all entities within the margining group. Intra-group transactions (transactions between two counterparties within the same margining group) are excluded from the calculation unless otherwise required by APRA;

reference period — is the period of time in respect of which month-end totals must be used to calculate the aggregate month-end average notional amount (see Tables 1 and 2);

qualifying level — is the level of aggregate month-end average notional amount for a reference period, in relation to the margining group of an APRA covered entity and the margining group of a covered counterparty, above which an APRA covered entity is subject to variation margin or initial margin requirements in the corresponding margining period (see Tables 1 and 2);

Genuine amendments to existing derivative transactions do not qualify as a new derivative transaction. This includes any amendments made solely for the purpose of addressing benchmark reforms. Any amendment that extends an existing derivative transaction for the purpose of avoiding margin requirements must be considered a new derivative transaction. The novation of a grandfathered transaction, application of standard trade maintenance processes on a grandfathered transaction or a transaction that results from portfolio compression of grandfathered transactions, does not qualify as a new derivative transaction. However, a transaction resulting from compression of both grandfathered transactions and transactions which are subject to mandatory margin requirements is subject to the margin requirements in this Prudential Standard.

derivative — is either of the following:

but does not include any arrangement that is of a kind mentioned in subregulation 6(2) of the Payment Systems and Netting Regulations 2001;[4]

For clarity, physically settled FX forwards and swaps must be included in the calculation of aggregate month-end average notional amount for the purposes of determining whether qualifying levels are exceeded, but may be excluded from the calculation of variation margin and initial margin to be exchanged.

For clarity, the fixed physically settled FX transactions associated with the exchange of principal in cross-currency swaps may also be excluded from the calculation of variation margin to be exchanged. All other risks associated with cross-currency swaps must be included in the calculation of variation margin to be exchanged.

netting agreement — is an ‘eligible bilateral netting agreement’ within the meaning of Prudential Standard APS 112 Capital Adequacy: Standardised Approach to Credit Risk (APS 112), except that all references to ‘ADI’ are replaced with ‘APRA covered entity’;

Refer to paragraphs 59 to 63 of this Prudential Standard for the treatment of intra-group transactions.

Refer to footnote 8.

Refer to footnote 9.

For the avoidance of doubt, an APRA covered entity is not required under this Prudential Standard to have initial margin documentation, custodial arrangements and operational processes in place for posting and collecting initial margin with a margining group if the bilateral initial margin amount is less than AUD 75 million.

RSE licensee — has the same meaning as in the SIS Act;

minimum transfer amount — is the amount specified in a margin agreement that sets the minimum amount of collateral required to be transferred between the two counterparties as part of a collateral call;

For avoidance of doubt, the only payments that may be excluded from initial margin requirements for a cross-currency swap are the fixed physically settled FX transactions associated with the exchange of principal. All other payments or cash flows that occur during the life of the swap must be subject to initial margin requirements.

The 10-day requirement applies in the case that variation margin is exchanged on a daily basis. If variation margin is exchanged at less than daily frequency, the minimum time horizon must be set equal to 10 days plus the number of days in between variation margin exchanges.

asset class — for the purposes of this Prudential Standard, the asset classes are (1) currency/rates, (2) equity, (3) credit, and (4) commodities. The asset class ‘currency/rates’ includes currency, interest rate and inflation derivatives. The asset class ‘commodities’ includes gold, silver and platinum;

This applies to all products including those which have risk exposures in multiple asset classes (e.g. quantos).

For the avoidance of doubt, eligible collateral for margining purposes is distinct from the eligible collateral under APS 112 that can be used to reduce the credit risk capital requirement.

Wrong-way risk occurs when the value of the collateral collected exhibits a significant correlation with the creditworthiness of the counterparty or the value of the underlying non-centrally cleared derivatives portfolio in a way that undermines the effectiveness of the protection offered by the collateral collected.

For clarity, while an APRA covered entity may have approval to use a model to calculate haircuts on collateral for the purpose of calculating regulatory capital, a separate approval by APRA is required for the use of a model in calculating haircuts for margining collateral.

Classes of collateral must be consistent with the categories in Table 4 of Attachment B to this Prudential Standard and include (1) cash; (2) debt securities under paragraph 47(b) of this Prudential Standard; (3) debt securities under paragraphs 47(c), 47(d), 47(e) and 47(f) of this Prudential Standard; (4) equities; and (5) gold. Foreign exchange haircuts must be modelled consistently for all collateral classes.

For a life company or a friendly society, non-centrally cleared derivative transactions between any of its funds (e.g. statutory fund, benefit fund, management fund or shareholder fund) are not in the same Level 2 group and are therefore subject to the variation margin requirements.

BCBS-IOSCO framework — is the margin requirements for non-centrally cleared derivatives as set out by the Basel Committee on Banking Supervision (BCBS) and the Board of the International Organization of Securities Commissions (IOSCO) in Margin requirements for non-centrally cleared derivatives as it exists at 23 July 2019;

For the avoidance of doubt, all requirements in this Prudential Standard are margin requirements except for the risk mitigation requirements in paragraphs 73 to 95 of this Prudential Standard.

For the avoidance of doubt, this includes an APRA covered entity to which subparagraph 66(a) of this Prudential Standard applies and the entity would be compliant with the foreign margin requirements or provisions in their entirety if the entity were directly subject to the requirements or provisions.

A long form confirmation that meets the conditions in paragraph 76 of this Prudential Standard and is received as soon as practicable after the execution of a transaction is considered to satisfy the requirement for trading relationship documentation.

This requirement applies to all transactions including transactions entered into from novation.

For example, a pay-fixed AUD interest rate swap with maturity of three years and notional of AUD 100 million could be netted against a pay-floating AUD interest rate swap with maturity of three years and notional of AUD 50 million to arrive at a single notional of AUD 50 million to which the appropriate initial margin rate would be applied. Derivatives with different fundamental characteristics such as the underlying, maturity etc. may not be netted against each other.