Element 5: Treatment of Provided Initial Margin

Effective from 2020-10-05 - Oct 04 2020
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Because the exchange of initial margin on a net basis may be insufficient to protect two market participants with large gross derivatives exposures to each other in the case of one firm’s failure, the gross initial margin between such firms should be exchanged. Initial margin collected should be held in such a way as to ensure that (i) the margin collected is immediately available to the collecting party in the event of the counterparty’s default, and (ii) the collected margin must be subject to arrangements that protect the posting party to the extent possible under applicable law in the event that the collecting party enters bankruptcy.
39.	Initial margin should be exchanged on a gross basis and held in a manner consistent with the principle above.
40.	The collateral arrangements should be effective under relevant laws and supported by periodically updated legal opinions.
41.	Cash and non-cash collateral collected as variation margin may be re-hypothecated, re-pledged or re-used.
42.	Except where re-hypothecated, re-pledged or re-used in accordance with paragraph 43 below, cash and non-cash collateral collected as initial margin should not be rehypothecated, re-pledged or re-used.
43.	Cash and non-cash collateral collected as initial margin from a customer may be rehypothecated, re-pledged or re-used (henceforth re-hypothecated) to a third party only for purposes of hedging the initial margin collector’s derivatives position arising out of transactions with customers for which initial margin was collected and it must be subject to conditions that protect the customer’s rights in the collateral, where applicable. In any event, and upon approval from SAMA on a case by case basis, the customer’s collateral may be re-hypothecated only if the conditions described below are met:
	•	The customer, as part of its contractual agreement with the initial margin collector and after disclosure by the initial margin collector of (i) its right not to permit rehypothecation and (ii) the risks associated with the nature of the customer’s claim to the re-hypothecated collateral in the event of the insolvency of the initial margin collector or the third party, gives express consent in writing to the re-hypothecation of its collateral. In addition, the initial margin collector must give the customer the option to individually segregate the collateral that it posts.
	•	The initial margin collector is subject to regulation of liquidity risk.
	•	Collateral collected as initial margin from the customer is treated as a customer asset, and is segregated from the initial margin collector’s proprietary assets until re-hypothecated. Once re-hypothecated, the third party must treat the collateral as a customer asset, and must segregate it from the third party’s proprietary assets. Assets returned to the initial margin collector after re-hypothecation must also be treated as customer assets and must be segregated from the initial margin collector’s proprietary assets.
	•	The collateral of customers that have consented to the re-hypothecation of their collateral must be segregated from that of customers that have not so consented.
	•	Where initial margin has been individually segregated, the collateral must only be re-hypothecated for the purpose of hedging the initial margin collector’s derivatives position arising out of transactions with the customer in relation to which the collateral was provided.
	•	Where initial margin has been individually segregated and subsequently rehypothecated, the initial margin collector must require the third party similarly to segregate the collateral from the assets of the third party’s other customers, counterparties and its proprietary assets.
	•	Protection is given to the customer from the risk of loss of initial margin in circumstances where either the initial margin collector or the third party becomes insolvent and where both the initial margin collector and the third party become insolvent.
	•	Where the initial margin collector re-hypothecates initial margin, the agreement with the recipient of the collateral (ie the third party) must prohibit the third party from further re-hypothecating the collateral.
	•	Where collateral is re-hypothecated, the initial margin collector must notify the customer of that fact. Upon request by the customer and where the customer has opted for individual segregation, the initial margin collector must notify the customer of the amount of cash collateral and the value of non-cash collateral that has been re-hypothecated.
	•	Collateral must only be re-hypothecated to, and held by, an entity that is regulated in a jurisdiction that meets all of the specific conditions contained in this section and in which the specific conditions can be enforced by the initial margin collector.
	•	The customer and the third party may not be within the same group.
	•	The initial margin collector and the third party must keep appropriate records to show that all the above conditions have been met.
44.	Banks should disclose the level and volume of re-hypothecation as required in section “Reporting to SAMA” below.

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