NAFMII Issues VM Guide to Aid Compliance with China NFRA Margin Rules

The Chinese Mainland’s¹ regulatory framework for margining of non-centrally cleared derivatives transactions continues to take shape. As previously announced, the variation margin (“VM”) requirements under the Administrative Measures on Margin Requirements for Non-centrally Cleared Derivatives Transactions of Financial Institutions promulgated by the National Financial Regulatory Administration (the “NFRA Margin Rules”) will come into force on 1 September 2026. In-scope financial institutions will be required to exchange VM for in-scope derivative transactions to mitigate mark-to-market exposure.

The NAFMII VM PAD is adapted from the NAFMII Title Transfer Performance Assurance Document (2009 version) (“2009 Title Transfer PAD”), with adjustments made to reflect the VM requirements under the NFRA Margin Rules. It follows the familiar NAFMII architecture of standard terms supplemented by a set of bespoke provisions. The standard terms of the NAFMII VM PAD consist of 11 clauses including, among other subjects, margin delivery and return, calculations and valuations, transfer of title, substitution of collateral, dispute resolution, interest amounts and manufactured distributions, and provisions relating to default and termination. Market participants are not expected to amend the standard terms; instead, their agreed variation margin arrangements are implemented primarily through elections and customisations set out in the supplemental provisions. The NAFMII-published version of the supplemental provisions also includes drafting notes (“Drafting Notes”), which make them more user-friendly and help to streamline both the drafting and negotiation.

The NAFMII VM PAD may be used in conjunction with both the NAFMII Master Agreement (2009 version) (“2009 Master Agreement”) and the NAFMII Master Agreement (Cross-border 2022 version) (“2022 Master Agreement”, and together, the “Master Agreements” or either, a “Master Agreement”). When used with the 2009 Master Agreement, parties must comply with Clause 23 of that Agreement, which restricts amendments to certain provisions through the supplemental provisions including the governing law (which must be Chinese Mainland law). By contrast, no such restriction applies when the NAFMII VM PAD is used with the 2022 Master Agreement, allowing greater flexibility, including the choice of offshore governing law.

Consistent with international practice, the NAFMII VM PAD adopts a title transfer credit support arrangement³, under which eligible collateral is transferred outright to the receiving party. When cash is provided as eligible collateral or equivalent credit support, it must be transferred to the receiving party’s designated cash account; when eligible collateral or equivalent credit support is provided in the form of book-entry securities, the relevant transfer and registration procedures must be completed in accordance with applicable rules. In practice, the implementation of title transfer for non-cash VM is also dependent on the availability of relevant financial market infrastructure systems to support such transfer and registration. The relevant bond registration authorities are currently upgrading their systems to align with and facilitate title transfer for VM. This does not, however, affect the current implementation of NAFMII VM PADs, as most of VM is posted in cash at present.

Similar to 2009 Title Transfer PAD, the NAFMII VM PAD - grounded in rationale and principles that parallel those of the ISDA framework - serves as a supplement to the applicable NAFMII Master Agreement and forms an integral part of the overall agreement structure. Accordingly, in the event of default or early termination, the value of any transferred VM will be treated as an unpaid amount and included in the close-out netting calculation, rather than being recovered through separate collateral enforcement procedures⁴ .

For regulatory compliance purposes, global financial institutions are typically required to obtain jurisdiction-specific legal opinions confirming the validity and enforceability of the NAFMII VM PAD. Unlike some international industry bodies and without precluding such practices from developing over time as the market continues to mature, NAFMII does not presently commission market-standard legal opinions for its standard documentation. Against this background, global financial institution inevitably are, as a practical matter, required to obtain clean netting and collateral enforceability opinions in relation to the NAFMII VM PAD, which we are well placed to support and provide. In issuing such clean opinions, regard would be had to the fundamental principles underpinning the Civil Code⁵ and the statutory framework established under the Futures and Derivatives Law⁶ , both of which recognise the legal validity and enforceability of close out netting provisions, and the outright transfer of onshore collateral significantly mitigates the risk of recharacterisation or challenge.

Compared with 2009 Title Transfer PAD, the NAFMII VM PAD introduces specific provisions designed to satisfy margin requirements under the NFRA Margin Rules. These include, among others, a defined settlement date to facilitate the timely transfer of eligible collateral or equivalent credit support, and provisions addressing the treatment of collateral that has been posted but subsequently ceases to meet regulatory eligibility criteria. For market participants, these enhancements are expected to improve operational clarity and reduce potential disputes regarding margin delivery and collateral eligibility under the new regulatory framework.

The NAFMII VM PAD, developed with reference to rationale and principles that are broadly consistent with those adopted in the ISDA framework, applies a daily mark-to-market mechanism, requiring parties to calculate and exchange VM to align the value of transferred VM collateral with the parties’ net exposure. The calculation is based on the concepts of “Delivery Amount” and “Return Amount”, which represent the net exposure between the parties after taking into account collateral already posted. Notably, after two rounds of consultation, the NAFMII VM PAD retains the concepts of Independent Amount (IA)⁷ and Threshold Amount (TA)⁸ used in 2009 Title Transfer PAD. These parameters may be set by counterparties based on their own risk and credit considerations, providing flexibility to avoid unnecessary small-scale collateral transfers.

However, under the NFRA Margin Rules, the threshold for VM is set to zero, meaning that all market-to-market exposure must be collateralized. Where the NFRA Margin Rules do not apply to one or both parties, the TA mount can be freely agreed between the parties. Non-regulatory IA may also be included between counterparties otherwise in-scope for VM, but additional drafting and structural consideration may be required.

According to the Drafting Notes, collateral transfers under the NAFMII VM PAD constitutes a “Transaction” under the Master Agreement and are intended to mitigate mark-to-market exposure by being included into the calculation of amounts payable upon early termination. A failure by to pay or deliver eligible collateral, equivalent collateral, interest amounts, or dividend equivalents under the NAFMII VM PAD constitutes a “Performance Assurance Default” under Clause 6 (II) of the 2022 Master Agreement, with no any grace period unless otherwise agreed in the supplemental provisions. This contrasts with ISDA practice, where title transfer credit support documents are generally not designated as “Credit Support Documents” in the ISDA schedule, and a failure to transfer collateral is categorized as a “Failure to Pay or Deliver” Event of Default under the ISDA Master Agreement.

The NAFMII VM PAD expressly provides that it is executed as a performance assurance document to fulfil the parties’ obligations under the 2009 Master Agreement or 2022 Master Agreement. From this perspective, a failure to pay or deliver eligible collateral constitutes a “Performance Assurance Default.” At the same time, the collateral arrangements under the NAFMII VM PAD also form a “Transaction” under the agreement, the same failure could equally be regarded as a “Failure to Pay or Deliver.” Accordingly, it is arguable that a default under the NAFMII VM PAD may constitute both.

It is worth noting that the second consultation draft of the NAFMII VM PAD aligned more closely with ISDA practice, classifying a failure to pay or deliver eligible collateral as a “Failure to Pay or Deliver” Event of Default with a grace period. In the final version, however, NAFMII adopted the “Performance Assurance Default” approach, likely because the 2009 Master Agreement already defines both Pledge Performance Assurance Document (2009 version) and 2009 Title Transfer PAD as “Performance Assurance Documents”.

8. According to the Drafting Notes, TA represents the tolerance that the transferee of collateral is willing to grant to the transferor. It does not need to be calculated or paid separately but is incorporated into the calculation of the Transferee’s Adjusted Exposure.

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