In a recent ISDA survey of derivatives users, the introduction of margin requirements for non-cleared derivatives was highlighted as a key area of concern, with nearly two thirds of respondents who knew they would be subject to the rules saying they were worried about their ability to meet the requirements. That’s little wonder. Once implemented, the majority of derivatives market participants will need to post initial and variation margin on their non-cleared over-the-counter (OTC) trades. For many entities, it will be the first time they’ve had to post collateral on non-cleared transactions, and it comes with a whole host of infrastructure and documentation challenges.
ISDA is playing a leading role in helping the industry prepare for these changes – as a new webinar on WGMR implementation highlights.
These initiatives can be broadly split into three key areas, each aimed at safely and effectively implementing the global margin rules. First, the rules will require existing legal documentation between counterparties to be changed, and ISDA is leading the re-writing of these contracts. Second, third-party segregated accounts will need to be set up, along with systems and processes to oversee the exchange and settlement of collateral. Third, ISDA is working with its member firms to develop a standard initial margin methodology to establish a single, regulator-approved model that all market participants can use to exchange collateral in a manner that is consistent with the rules.
The development of this standard initial margin model (SIMM) has its roots in the 2013 WGMR requirements, which gave market participants the choice of using a standard table set by regulators or an internal model to calculate initial margin. The former is likely to lead to punitive margin requirements, but the latter creates the risk that each firm will develop its own margin model, leading to a situation where no two counterparties are able to agree on the initial margin amounts that need to be exchanged.
The SIMM will create a framework that all counterparties can use to calculate initial margin, reducing the potential for disputes. A proposed methodology was developed at the end of last year based on a standardised capital calculation described by the Basel Committee on Banking Supervision in its fundamental review of the trading book. Regulators have seen this methodology and are continuing to review it.
But there’s a lot that still needs to be done, and a short amount of time to do it in. Under the original framework published in September 2013 by the Working Group on Margining Requirements (WGMR), a body jointly run by the Basel Committee on Banking Supervision and International Organization of Securities Commissions, initial margin requirements will be phased in from December 2015, starting with the largest derivatives users. Variation margin rules, however, are scheduled to come into force for all covered entities from the end of this year.
The implementation time frame is made harder by the fact that final rules have not yet been published by the various national authorities. European regulators published their proposals in April, followed by Japan in July, US prudential regulators in early September and the Commodity Futures Trading Commission later that month.
Those proposals also contain a number of regional discrepancies, including issues as basic as the scope of coverage and the threshold for margin requirements to kick in. It’s uncertain whether these differences will remain in the final versions of the national rules, or whether the most problematic issues will be ironed out. Either way, it has added to the preparation challenges for firms.
That’s why ISDA has requested additional time to prepare from the point the final rules are published. ISDA sent a letter to the WGMR last August asking for a longer implementation period in light of the scale of the work needed to prepare for the rules, and there are indications that regulators are considering this.
Equally importantly, though, is the need for harmonisation of the various rules. OTC derivatives markets are global – counterparties often trade across borders. If one party calculates margin using the rules applied in its jurisdiction and a foreign counterparty ends up with a different number based on its national requirements, cross-border trading will become much more difficult. The result? Less choice and the fragmentation of liquidity.