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To ensure that assets collected as collateral for initial and variation margin purposes can be liquidated in a reasonable amount of time to generate proceeds that could sufficiently protect collecting entities covered by the requirements from losses on non-centrally cleared derivatives in the event of a counterparty default, these assets should be highly liquid and should, after accounting for an appropriate haircut, be able to hold their value in a time of financial stress. The set of eligible collateral should take into account that assets which are liquid in normal market conditions may rapidly become illiquid in times of financial stress. In addition to having good liquidity, eligible collateral should not be exposed to excessive credit, market and FX risk (including through differences between the currency of the collateral asset and the currency of settlement). To the extent that the value of the collateral is exposed to these risks, appropriately risk-sensitive haircuts should be applied. More importantly, the value of the collateral should not exhibit a significant correlation with the creditworthiness of the counterparty or the value of the underlying non-centrally cleared derivatives portfolio in such a way that would undermine the effectiveness of the protection offered by the margin collected (ie the so- called “wrong way risk”). Accordingly, securities issued by the counterparty or its related parties should not be accepted as collateral. Accepted collateral should also be reasonably diversified.
32.
SAMA only considers eligible collaterals, which are allowed under the standardised approach for credit risk under the Risk-based Capital Framework adopted by SAMA, subject to appropriate haircuts described below.
33.
Potential methods for determining appropriate haircuts include either internal or third- party quantitative model-based haircuts or schedule-based haircuts. Banks should apply standardised schedule-based haircuts as defined in Appendix B. If higher haircuts are proposed by different regulators in international jurisdictions, the higher haircut should be applied.
34.
Risk-sensitive quantitative models, both internal or third-party, could be used to establish haircuts provided that the model is approved by SAMA and subject to appropriate internal governance standards.
35.
Banks should not selectively apply the method for determining appropriate haircuts that would produce a lower haircut, banks should consistently adopt either the standardised tables approach or the internal/third-party models approach for all the collateral assets within the same well defined asset class.
36.
In addition to haircuts, other risk mitigants should be considered when accepting noncash collateral. In particular, banks should ensure that the collateral collected is not overly concentrated in terms of an individual issuer, issuer type and asset type.
37.
In the event that a dispute arises over the value of eligible collateral, both parties should make all necessary and appropriate efforts, including timely initiation of dispute resolution protocols, to resolve the dispute and exchange any required margin in a timely fashion.
38.
Collateral that is posted by a counterparty to satisfy margin requirements may, at some point in time before the end of the derivatives contract, be needed by the counterparty for some particular reason or purpose. Alternative collateral may be substituted or exchanged for the collateral that was originally posted provided that both parties agree to the substitution and that the substitution or exchange is made on the terms applicable to their agreement. When collateral is substituted, the alternative collateral must meet all the requirements outlined above. Further, the value of the alternative collateral, after the application of haircuts, must be sufficient to meet the margin requirement.
