Time Ticking on Next Margin Deadlines

Time has a habit of marching relentlessly on, and revised compliance dates for counterparties to make changes to their collateral documents as part of new variation margin requirements are nearly upon us in some cases. Substantial progress has been made over the past few months because the industry isn’t being complacent – yet there’s still more to do, and little time to do it in.

ISDA has been tracking industry progress on a weekly basis since the beginning of the year. The data shows that more than three quarters of outstanding credit support annex (CSA) agreements have now been amended. That represents a big jump from the 30% just before the original variation margin ‘big bang’ implementation date of March 1 – which, in turn, represents thousands of hours of complex bilateral negotiations with counterparties to agree the changes. We have provided this information to regulators across the globe, and they are keenly interested in the progress that has been made.

But with the variation margin forbearance period set to end on September 1 in some jurisdictions, including the US, there’s little time left to make changes to the remaining 20-25% of CSAs. Along with the end of forbearance, other jurisdictions – Australia, Hong Kong, Switzerland and Singapore – are due to require compliance with their variation margin requirements from September 1.

Given the progress made over the past few months, it might seem like there’s time aplenty to complete the job. But the second phase of the initial margin requirements is also due to take effect on September 1 – which means that phase-one and phase-two banks will be finalizing their initial margin documents, and phase-two firms will be implementing the necessary systems changes. It should also be noted that the ISDA SIMM has been updated to include additional risk factors relating to cross-currency swaps, inflation swaptions and collateralized debt obligation tranches. ISDA SIMM 1.3 was undertaken at the request of the Federal Reserve Bank, and we’re also going through the annual recalibration process and the results will be shared with global regulators. All of this means there will be competing demands for limited resources during the coming summer months.

The scale and complexity of the variation margin repapering exercise has been immense. The March 1 deadline captured banks, asset managers, insurance companies and hedge funds across the US, European Union, Japan and Canada. While the vast majority of those entities already posted variation margin on their non-cleared derivatives, the rules required certain specific changes to be made to collateral documents in order to comply with the rules. ISDA estimates more than 150,000 CSAs needed to be amended – and all changes had to be negotiated and agreed by each pair of counterparties.

ISDA has been focused on helping firms with their compliance efforts, and published a protocol that offers a scalable option for amending multiple CSAs to comply with the variation margin requirements. That protocol remains open, and has been extended to include Australia, in addition to the US, Canada, European Union and Japan. We would urge firms to push ahead with their remaining negotiations, and aim to complete the work as soon as possible.

There is a potentially troubling aspect to this, though. There have been questions over whether regulators might require trades entered into from March 1 to be unwound if they are not subject to regulatory compliant variation margin CSAs by September 1. This action is both counterproductive to good risk management and impracticable, as firms lack a contractual mechanism to force their counterparties to unwind the transactions in those circumstances.

Even if achievable, such a requirement would be unlikely to reduce systemic risk in any meaningful way, given ISDA data that shows approximately 90% of relationships that are in-scope for the repapering exercise are already backed by variation margin, just not with the required changes to the underlying documentation to bring them into full alignment with the regulatory mandated terms. Planning a program to unwind transactions would divert key resources away from the main task of completing the variation margin repapering and implementing the phase-two initial margin changes.

Due to the conditions of the available regulatory forbearance, market participants have been careful to engage in activity that does not present significant credit and market risks. Indeed, some trades entered into from March 1 may offset the risks of transactions entered into prior to that date. Forcing firms to unwind trades would therefore lead to significant market disruption, could result in some entities being left unhedged, and would disadvantage firms in a subset of jurisdictions, which could lead to regulatory arbitrage. That’s surely contrary to the intention of regulators.

ISDA will continue to track the industry progress and keep global regulators informed of the overall number of CSAs that have been renegotiated and updated leading up September 1. We are also helping all phase-two banks prepare for the next round of initial margin exchange utilizing SIMM 1.3.

ISDA’s Vision for a Smart Future

ISDA has a long history of creating solutions for the derivatives industry. The Master Agreement and countless protocols and definitions have contributed to a safer, more efficient market for derivatives users.

Now we face perhaps our biggest challenge to date. Due to tactical regulatory drivers and a lack of historic planning, many basic, vital processes in our market have become unbearably complex and inefficient. This needs to change – and ISDA is focused on working with the industry to produce new standards and ensure the derivatives market is building firm foundations for the future.

In my remarks at ISDA’s recent annual general meeting, I outlined a vision for a derivatives market structure that is more efficient, driven by common data, processes, legal standards and automation. This won’t happen overnight, so the industry needs to start planning for the longer term now. We need a wholesale rethink of the way the market is connected, how trade flows are managed, and how data is created and shared between participants. ISDA is committed to helping in this task, and we will do what we have always done – bring the industry together, find consensus and hammer out solutions.

The root of the problem can be traced back to the succession of requirements introduced as part of the post-crisis reform agenda. The industry has been focused intensely on meeting successive deadlines for clearing, trade execution, reporting, compression and collateral exchange. There has been little time to think about how all of this can best work together. As a result, processes and workflows are over-complex, duplicative and costly to maintain. The absence of a common approach means counterparties need to constantly reconcile details of a trade to reduce the potential for inconsistencies. This is sapping the energy and resources of all concerned.

Technology is the key to greater efficiency and creating value for our members – an issue on which there was broad consensus during our annual general meeting. For the potential of fintech to be fully realized, a strong foundation of common standards and processes must be constructed. Only then can innovators and entrepreneurs take new technologies forward with the confidence they will be interoperable.

In an ISDA white paper published in September, we set out the steps we think are needed to create those strong foundations. A critical aspect is the development and implementation of common data standards to ensure everyone can communicate the economic terms of a trade consistently across the lifecycle. ISDA has published principles governing product standards, and we have begun work to define appropriate product taxonomies. We’ve also been working with regulators to develop a suitable trade identifier framework, and will continue to feed into this process.

In addition, we need standards for processes – an agreed set of definitions for specific lifecycle events or actions, which could be encoded as common domain models that are available to everyone. This would not only aid interoperability; it would also provide a transparent and consistent view of how each step in the process works. This would help oversight and rule-making and simplify regulatory implementation, as specific changes to an affected common domain model could be recommended in order to comply.

Once that’s complete, we can develop smart contracts that provide an automated legal framework for derivatives, based on the standardized data and processing hierarchy. Here, the existing Financial products Markup Language framework could be leveraged and extended to support self-executing transactions – in fact, we’ve already rolled out a proof of concept of this.

Finally, we can’t ignore all the good work that ISDA and its members have contributed on the legal front. ISDA will work to future-proof our legal documentation by developing solutions to update and automate our product definitions, as well as exploring various smart contract applications.

These aren’t just ideas. We’re working with the industry – sell side, buy side, technology firms and lawyers – to put them into practice today. There are a lot of opinions out there, but achieving consensus on new standards is something ISDA has plenty of experience in, dating back to the development of the ISDA Master Agreement 30 years ago.

The goal we have set is a fundamental overhaul of the derivatives markets. This will bring increased automation, make it more cost efficient, and enable opportunities for innovation. This goal is ambitious, but ISDA and its members have the desire to bring about the necessary change to ensure the vitality of these markets in the future.

Certainty is Good for the Economy

It is often forgotten – or ignored – that derivatives serve a real economic purpose. They help companies manage risk, which creates certainty and stability. That stability gives those companies the confidence to invest, borrow, grow and hire. That contributes to economic growth.

ISDA recently put together a short video, along with a fact sheet, to highlight a few examples of how derivatives help companies run their businesses better.

Examples include companies using derivatives to lock in the cost of issuing debt to finance new investments. Exporters using derivatives to create certainty in the exchange rate at which they can convert future overseas revenues. Pension funds using derivatives to protect the value of pensions for future retirees. Food producers using derivatives to hedge crop and livestock prices. And banks and mortgage providers using derivatives to manage the risk from their loan books, enabling them to keep on lending.

In each case, these entities are using derivatives to create certainty. No one can predict how markets will move in future, but being able to lock in a foreign exchange or interest rate that a firm is comfortable with enables that company to better plan for the future. That’s incredibly valuable.

Now, let’s be clear: we think derivatives markets need to be safe and efficient, and the trading of these products needs to be accompanied by sound risk management. That’s why we have supported regulatory efforts since the crisis to improve transparency and mitigate counterparty credit risk. As a result of those measures, the financial system is more resilient than ever before.

But the bottom line is that derivatives continue to be used by a whole range of companies because they’re useful – because they help them manage risk. If they didn’t find them beneficial, they wouldn’t use them.

But don’t just take our word for it. Here are a couple of public statements from regulators in the US and Europe charged with reforming how derivatives are traded.

“[L]et us again be reminded of the essential role of global derivatives markets: to help moderate price, supply and other commercial risks – shifting risk to those who can best bear it from those who cannot. Thus, well-functioning global derivatives markets free up capital for business lending and investment necessary for economic growth – economic growth that still remains far too meager on both sides of the Atlantic.”

Acting CFTC chairman J. Christopher Giancarlo, ISDA Annual General Meeting, May 10, 2017

“Most Americans do not participate directly in the derivatives markets. Yet these markets profoundly affect the prices we all pay for food, energy, and most other goods and services. They enable farmers to lock in a price for their crops, utility companies and airlines to hedge the costs of fuel, exporters to manage fluctuations in foreign currencies, and businesses of all types to lock-in their borrowing costs. In the simplest terms, derivatives help businesses throughout the US economy manage risk.”

Former CFTC chairman Timothy Massad, Economic Club of New York, December 6, 2016

“Derivatives are a key part of our financial markets and account for hundreds of trillions of euros in volume. Under the right conditions, they contribute to financial stability, by allowing market participants to redistribute risk among each other. For example, they allow exporters to fix their prices despite fluctuating exchange rates, and banks to offer fixed-rate mortgages even as interest rates move.”

Valdis Dombrovskis, vice-president, European Commission, May 4, 2017

And here’s just one public statement from an association representing derivatives end users. There are plenty more out there in the public domain.

 “The use of derivatives to hedge commercial risk has key economic benefits. It allows businesses – from manufacturing to healthcare to agriculture to energy to technology – to improve their planning and forecasting, manage unforeseen and uncontrollable events, offer more stable prices to consumers and contribute to economic growth.”

Letter from Coalition for Derivatives End-Users, January 26, 2016

Safe AND Efficient Markets

Those of you who made the trip to Lisbon last week for our 32nd annual general meeting – or followed our updates and live streaming on Twitter – will know that several key themes dominated the event. But most can be grouped under a single word: efficiency.

This plays directly to ISDA’s mission statement to promote safe and efficient markets – a mission that is driving our focus on the future and our commitment to develop innovative new solutions. Attention from regulators and the industry in recent years has understandably been on the first of those – safety – but efficiency is just as important. Without it, costs rise and access to risk management tools diminishes.

There’s no doubt the financial system is now safer, more transparent and more resilient as a result of the post-crisis Group of 20 reforms. We think that progress is important and must be maintained. But we also think the regulatory framework can be made to work better by cutting complexity, eliminating duplication and removing unnecessary compliance burdens. As I pointed out in my AGM opening remarks, and as discussed in our panel discussion on public policy, there are many examples of complexity in the rules that result in higher costs for derivatives users and ultimately discourage trading, investment and hedging.

The reporting rules are a case in point. Most jurisdictions now have reporting rules in place, but the data that’s required to be reported and the form it has to be sent can differ significantly. In the US, for instance, Commodity Futures Trading Commission and Securities and Exchange Commission rules diverge on required data fields and the format of submission. This creates unnecessary duplication and inconsistency, without having any obvious benefit from a systemic risk-reduction perspective.

Fortunately, both European and US regulators are now reviewing their rules with an eye to making refinements where necessary. We welcome these initiatives, and believe eliminating pointless complexity and duplication is an important requisite for efficiency. Achieving greater cross-border harmonization and conducting thorough impact studies before all the rules come into force to understand their effect on the entire derivatives ecosystem are also important.

Looking at the regulatory framework is just one element of the drive for efficiency, though. We also need to remould the derivatives data and processing infrastructure to ensure it is fit for the future. The regulatory reform of derivatives markets has resulted in an array of new requirements and infrastructures – clearing houses, trading platforms and trade repositories – but the succession of deadlines has caused firms to take a tactical approach to compliance. The tight time frames haven’t given participants much time to think about the bigger picture.

The result is a lack of common standards and processes, and the need for constant reconciliation between counterparties. This inefficiency increases the cost and complexity of running a derivatives business.

A vital part of the answer is to develop a consistent data and process hierarchy. By using common data standards for products and trades, and agreeing standard processes that are encoded as common domain models, the industry can ensure the foundations for future growth are on a firm footing – as well as pave the way for the use of innovative new technologies like smart contacts.

ISDA published a white paper last September that set out the improvements in data and processes that are needed, and we’re committed to leading that effort. We’re keen to work with all participants – traders, technology firms and lawyers – to make this a reality, in the same way ISDA worked with the industry 30 years ago to achieve consensus on the ISDA Master Agreement.

As discussed on our technology panel at the AGM, the challenges are significant. But we need to be bold in developing a re-ordered, more efficient workflow. The continued efficiency of the derivatives market depends on it.

At ISDA, we have our eyes firmly fixed on the future, and we’ll look to bring the industry together to forge a consensus on the path forward. By drawing on our legal, data and technology expertise, the aim is to create the standards and processes needed for the market to function efficiently for the next 30 years.

Thanks to the 750 or so members who joined us in Lisbon and helped make the event a great success. Thanks also to the financial media who attended. We especially appreciate the global policy-makers – Svein Andresen (Financial Stability Board), J. Christopher Giancarlo (Commodity Futures Trading Commission), Steven Maijoor (European Securities and Markets Authority) and Kay Swinburne (European Parliament), among others – who provided their perspectives on key regulatory issues in the global derivatives markets.

Expanding ISDA SIMM Coverage

Developing the ISDA SIMM was never going to be a one-time deal – for ISDA to roll it out for the September 2016 implementation, and then walk away. It was always recognized that regular updates and recalibrations would be necessary, in line with regulatory requirements. And an important set of updates was introduced this month.

The ISDA SIMM now includes additional risk factors relating to cross-currency swaps, inflation swaps and collateralized debt obligation tranches, meeting a deadline set by US regulators last year for the model to incorporate those risk factors.

This is an important development for the industry. Cross-currency swaps, in particular, comprise a large portion of the non-cleared derivatives market – roughly $15 trillion in notional, according to data reported to US swap data repositories and compiled by ISDA SwapsInfo.org – and are widely used by end users to hedge their foreign currency exposures.

Failure to make the required updates would have meant having to calculate initial margin on new cross-currency swap transactions using the much more conservative standard table set by regulators, resulting in punitive margin requirements. This could have made this important hedging instrument uneconomic for some end users.

Support for these additional risk factors – rolled out on April 1 – is part of a series of phased updates requested by US regulators at the time they approved use of the ISDA SIMM by phase-one firms last August. Given the need to also run a parallel annual recalibration and methodology review, the ISDA SIMM Governance Executive Committee opted to focus on those products and risk factors that ISDA members had highlighted as priorities and where the necessary data history existed – with cross-currency swaps top of that list.

With that achieved on schedule, attention will focus on the next set of deadlines and priorities, as well as meeting the September 2017 implementation date for the second wave of firms subject to initial margin requirements. The ISDA SIMM Governance Forum is working to identify those institutions affected, and to share knowledge and experience from the September 2016 implementation.

Seven months on from the first implementation date, the ISDA SIMM is being widely used by phase-one firms, and is expected to be just as broadly adopted by the second wave. That was the point of the ISDA SIMM: to develop a simple methodology that could be used by everyone. A simple, industry wide model will never be as sophisticated as a bells-and-whistles bank internal model, but it will cut down on the problems that could have occurred had everyone developed their own, disparate methodologies. It won’t eliminate disputes but it should limit them, and the fact that everyone is using the same simple, transparent model will make it easier to trace the causes of any differences.

The ISDA SIMM will continue to be a major priority for ISDA, and the ISDA SIMM governance framework will ensure the model continues to meet regulatory requests, responds to member feedback, and reflects changing market conditions in a transparent, inclusive way.

Steps on the Way to China Netting

Anyone who knows ISDA knows we care passionately about close-out netting. It’s one of the bedrocks of good risk management, and results in drastically lower credit exposures between counterparties. Being able to squash the positive and negative values of multiple trades between a pair of counterparties into a single net payment from one to the other means a default is likely to be less disruptive to the financial system.

We’ve long campaigned for netting certainty, and we’ve worked with authorities across the globe to help them draft legislation on the enforceability of close-out netting. Off the back of that work, we’ve so far commissioned netting opinions in more than 60 countries, with others in the pipeline.

That work continues, and we’re making progress in a number of areas – including in China, where we recently published a netting opinion for certain Chinese sovereign entities and an update to our China netting memorandum.

The netting opinion states that certain agencies that act on behalf of the government – the People’s Bank of China, the Ministry of Finance and the State Administration of Foreign Exchange – are not subject to any bankruptcy regime in China. That means the legal issues relating to bankruptcy stays, an administrator’s ‘cherry-picking’ right and statutory set-off under China’s Enterprise Bankruptcy Law are not applicable. They would therefore not affect the enforceability of contractual early termination and netting provisions in the ISDA Master Agreements held by these entities.

The updated netting memo, meanwhile, builds on an earlier release in 2014, and provides more detail on bankruptcy proceedings for China’s commercial banks, securities companies and insurance firms. It also includes an updated discussion on changes that should be made to the ISDA Master Agreement when ’automatic early termination’ is specified as applying to a Chinese counterparty, so all outstanding transactions under the agreement are terminated automatically if there’s a bankruptcy petition relating to that counterparty. Alongside a collateral memo we published in 2016, it goes a long way to helping firms build a picture about the state of play and the issues they need to consider when trading with Chinese entities that are subject to the Enterprise Bankruptcy Law.

These are all important steps to the ultimate goal: to have legislation in China that recognizes the enforceability of close-out netting. To that end, we’ll be taking the next step in June, when we host a seminar in Beijing on the benefits of close-out netting.

We believe the development of close-out netting legislation in China would create more certainty for financial institutions, and encourage more participation. Once these elements are introduced, the conditions will be in place for China’s derivatives markets to further develop and flourish, providing end users with a means of managing their interest rate and foreign currency exposures.

The Past and the Future

There’s a lot we take for granted in the derivatives space. The fact there’s a common language, for example – an agreed set of definitions and standard terms everyone can agree on. This means there’s a common foundation for negotiating trades, whatever the product and whatever the jurisdiction. But it wasn’t always like this, and it certainly wasn’t inevitable we’d get to this point.

Look back to the early 1980s, and the derivatives market was very different. Then in its infancy, each deal involved weeks and weeks of tortuous negotiations to agree terms. This was because each bank had developed its own contract, each with its own unique terms and definitions – something frustrated lawyers referred to as multiple agreement disorder, or MAD.

ISDA was established in response to this mess, and the result was the ISDA Master Agreement, a standard document that essentially removed the shackles from the derivatives market and set it on its path of growth. That was 30 years ago this month – an anniversary we celebrated with those who helped create the Master Agreement at Middle Temple Hall in London last night. Thirty years on, the Master Agreement is still as important as it was in 1987, and it stands as a perfect example of the industry cooperating to create something flexible, comprehensive and durable.

Jump to 2017, and the industry faces a new set of challenges that are equally as significant. Market participants now face a complex web of execution and post-trade management processes, largely as a result of regulatory change. Managing a trade through its lifecycle has become resource-intensive and costly as a result.

New technology – smart contracts and distributed ledger systems, in particular – offers the chance to mitigate these inefficiencies. The potential is enormous, but, as with the derivatives markets 30 years ago, the foundations need to be right. That means coming up with standard definitions and processes, and building the structure on a strong legal framework.

Just as with the development of the Master Agreement, ISDA is the perfect place for this to happen. We’ve already started work on this, and published a white paper last year on the future direction of derivatives processing and market infrastructure.

There is plenty of work to be done on smart contracts. We need to bring technology partners and members together to create the appropriate balance of automatable and enforceable agreements. Some of the most fundamental challenges include how to represent contractual obligations in a standard code using well-defined processes and definitions, and anticipating and developing the means to redress extraordinary events of a discretionary nature during the lifecycle of a trade. The territory between automated processes and those requiring human intervention will need to be clearly defined.

We’ve been restructuring our working groups to start discussing these issues. The work on smart contracts, process automation and a consistent data taxonomy is in the early stages. But it’s an incredibly exciting place to be. And, just with the publication of the Master Agreement 30 years ago, it could be transformational for the derivatives market.

Keeping the Foot on the Pedal

Over the past week, regulators across the globe have responded to looming market disruption by providing flexibility to derivatives users in their attempts to meet a March 1 deadline for posting variation margin on their non-cleared derivatives trades. This flexibility was critical. With firms struggling to amend their collateral documents in time, there was a very real risk that derivatives users would have been unable to trade from tomorrow, as ISDA and others warned in a letter earlier this month.

Thanks to well-coordinated action taken by global regulators to provide forbearance, that danger has now receded. The exact nature of the relief differs jurisdiction to jurisdiction, but regulators have generally provided derivatives users with additional time to finish making the changes to their credit support annex (CSA) agreements.

Given most derivatives counterparties already exchange variation margin on their non-cleared trades, this additional flexibility will not lead to an increase in systemic risk. It will, however, ensure counterparties have more time to negotiate the complex changes to their outstanding CSAs to ensure these documents reflect new regulatory edicts on eligible collateral, settlement timing and haircuts.

That process of negotiation has been complicated and time-consuming, and the scale of the task has been overwhelming. The March 1 ‘big bang’ implementation date captures banks, asset managers, insurance companies and hedge funds, and involves updating more than 150,000 CSAs. The time scale in which to make those changes has also been impossibly short. Market participants had to wait for final rules from national authorities to know exactly what changes were needed and how to phrase the amendments to create legal certainty, but those rules were published a matter of months ago in some cases.

According to the most recent survey numbers from ISDA, only 15.31% of active and new CSAs had been executed by February 17. That represents a doubling from the week before, but indicated that a large proportion of the market wouldn’t have been ready by March 1.

The flexibility afforded by regulators gives the industry more time to get that work done, and will minimize market disruption and maintain market access for a variety of derivatives users. But that does not mean market participants will sit on their hands. The industry remains committed to completing the necessary work as quickly as possible, and ISDA will continue to monitor and report progress in the weeks ahead.

Summary of regulatory action:

IOSCO statement

Commodity Futures Trading Commission

US prudential regulators

European Supervisory Authorities

Financial Conduct Authority

Central Bank of Ireland

Australian Prudential Regulation Authority

Monetary Authority of Singapore

Hong Kong Monetary Authority

Office of the Superintendent of Financial Institutions

CFTC Action Welcome, But More Needed

For some time now, we’ve been warning that many derivatives users wouldn’t meet a March 1 deadline to amend their credit support annex agreements (CSA) in order to comply with new variation margin requirements. Yesterday’s announcement of a six-month transition by the Commodity Futures Trading Commission (CFTC) is therefore very welcome. It leaves the March 1 start date intact, but allows firms to continue trading while they finish the substantial work needed to amend their documents.

As our letter to regulators last week pointed out, sticking with March 1 without such transitional relief would have caused unnecessary market disruption. Most firms already post variation margin on their non-cleared derivatives trades, but face being shut out of derivatives markets unless they manage to amend their outstanding collateral documents. The scale of the task is huge – we estimate approximately 160,000 CSAs need to be updated. Despite a determined industry effort, CSA negotiations have proved to be hugely complex and time consuming. Last week, we disclosed our latest industry survey data, which showed only 4.43% of CSAs had been amended.

The CFTC has taken a practical approach to this issue. Its relief letter provides market participants with a six-month transition that enables firms to continue to access derivatives markets. During that six-month period, counterparties must show they are working hard to complete the necessary CSA amendments, and all swaps entered into from March 1 must be compliant by September 1, 2017.

This is similar to relief provided late last year by Australian regulators. Hong Kong and Singapore have also provided six-month transitions.

But while welcome, this relief needs to be complemented by similar action from other regulators. Unless a globally coordinated transition is agreed, there is a risk of market fragmentation, with counterparties shifting trading relationships to those entities or regions that have secured relief. Given the fact many counterparties have existing variation margin arrangements, this would cause significant disruption for no purpose.

We think all derivatives users should be able to access derivatives markets from March 1. As such, we urge global regulators to work together to provide consistency across jurisdictions.

Time Running Out

First, the good news. The number of credit support annexes (CSAs) that had been amended to meet new regulatory variation margin requirements more than doubled during the past week. The bad news is the overall proportion is still very low, at just 4.43%. With less than three weeks before deadline, it’s difficult to see how every one of the thousands of firms affected will be ready and able to continue accessing derivatives markets from March 1.

The market disruption this would cause is the reason why ISDA and a group of other trade associations, representing both buy and sell side, wrote to regulators earlier this week asking for a transition period. Under one possible scenario, the requirements would come into force as planned on March 1, but market participants would be able to continue trading while they finish their documentation updates. As with the forbearance provided by Australia in December, regulators could ask for trades conducted during that transition to be backloaded to the effective date, therefore keeping pressure on the market to amend their documents.

Seeing as most counterparties already post variation margin, this transitional period won’t lead to an increase in systemic risk. But denying a vast swath of market participants access to derivatives markets because they haven’t updated their documentation would create significant problems, with smaller end users likely the most affected. We think it’s important that all users of derivatives are able to continue to access derivatives markets to hedge from March 1 – hence the request for forbearance.

The obvious question is why progress has been so limited. The simple answer is that the legal and operational challenges of amending, replacing or executing roughly 160,000 CSAs is huge. The terms of those CSAs already in place with clients tend to be highly variable, which has required bilateral negotiations between each counterparty pair to agree the necessary changes. Despite determined efforts to get this done by the industry, supported by ISDA, the bespoke nature of many of these agreements has meant these negotiations have been complex and time consuming.

Once amended, these documents then have to be loaded into reference data systems and activated for trading. Operations staff are working hard to get this done, but the numbers are overwhelming. So far, just 12.29% of those CSAs that have been amended have been loaded up.

So, progress has been made, and derivatives users will continue to push as hard as they can. But March 1 looks extremely optimistic. As it stands, we think there is a material risk that a large proportion of firms won’t be ready. That could result in fragmentation, market disruption, higher prices and the inability for end users to put on hedges.