Frequently asked questions on the liquidity risk treatment of settled-to-market derivatives

The Basel Committee today issued responses to Frequently Asked Questions (FAQs) related to the treatment of settled-to-market (STM) derivatives under the Liquidity Coverage Ratio (LCR) and Net Stable Funding Ratio (NSFR). 

The Committee has observed that an increasing number of banks are now recording variation margin on cleared derivatives as settlement payments rather than as transfer of collateral. These contracts are said to be "settled to market". This practice, which occurs particularly for cleared swaps, allows these banks to take ownership of the collateral they receive. Under STM, daily payments of mark-to-market variation margin are recorded as settlements of the derivatives transactions rather than transfers of collateral and the market value of the derivatives is reset daily to zero. 

The FAQ responses below seek to clarify that the liquidity risks associated with STM derivatives are the same as those for more conventional "collateralised-to-market" derivatives, and should therefore be treated in an equivalent manner. 

FAQs on the liquidity treatment of settled-to-market derivatives 

1. Should settlement payments (or receipts) made in the context of derivatives structured as "settled-to-market" (or "STM") be captured in paragraph 123 of the LCR rules text? 

Answer: Yes, if the settlements are made in relation to market valuation changes. The economic cash flows exchanged between parties to STM and non-STM derivatives are identical and therefore the "collateral flows" mentioned in paragraph 123 include payments and receipts which are deemed to settle outstanding exposures from derivatives structured as STM as well. 

2. How should derivatives structured as "settled-to-market" (or "STM") be captured in paragraph 43(d) of the NSFR rules text? 

Answer: Derivatives structured as "settled-to-market" should be included in the calculation of the 20% of derivative liabilities (with a national discretion for jurisdictions to lower the value of this factor, with a floor of 5%) specified in paragraph (43 (d)). The replacement cost amount of these derivatives should be calculated as if no settlement payments and receipts had been made to account for the changes in the value of a derivative transaction or a portfolio of derivative transactions.