No sooner had the first deadline for the posting of margin on non-cleared derivatives passed than attention had begun to switch to the next set of hurdles. There are some big challenges ahead – not least, the March 1 deadline for variation margin, which will capture a much wider universe of derivatives users. But meeting the implementation timetable isn’t the only thing the industry has to think about. Keeping the ISDA SIMM in line with regulatory requirements and ensuring it continues to reflect market conditions is another major preoccupation.
The ISDA SIMM – a common methodology for calculating initial margin – has been widely adopted by the largest, so-called phase-one derivatives users since the margin rules were rolled out in the US, Japan and Canada on September 1. But that doesn’t mean the job is done. Firms had to obtain approval from US regulators prior to using the ISDA SIMM on September 1. The approval letters began to arrive in August, but asked for phased updates to the methodology during 2017 as a condition for using the ISDA for certain product types.
That work is already under way, and the first round of modifications is due at the start of next year. In fact, many of the required enhancements had actually been earmarked by the industry for action once the initial September 1 deadline was out the way – for instance, further development of the treatment of cross-currency swaps. After all, the ISDA SIMM was never intended to be a static model, built once and then left for users to get on with it. It was always recognized that regular updates and recalibrations would need to be made.
The ISDA SIMM itself is relatively simple, designed to be used by the widest possible audience. Users need to determine their own sensitivity inputs for specified risk factors, but other parameters – risk weights, correlation and risk buckets – are centrally defined to help ensure consistency. Along with dealing with regulatory requests, these parameters need to be regularly reviewed and recalibrated.
As promised at the inception of the ISDA SIMM, this will all be done through a transparent governance framework, comprising an ISDA SIMM Governance Forum, which is open to all ISDA members that are subject to the initial margin requirements, and an ISDA SIMM Governance Executive Committee, which takes the decisions over alterations. These two entities are supported by ISDA staff and are overseen by the ISDA Board of Directors.
This governance committee will oversee an annual recalibration of these parameters and will conduct a yearly methodology review will ensure the model continues to perform as it should. A key part of this process will be feedback from users. By reporting difficulties with reconciliation or significant margin shortfalls, market participants will give the governance committee the right information to judge the performance of the model and make changes as necessary. Persistent or material shortfalls that are common to ISDA SIMM users could trigger an update outside the annual recalibration process.
The really important thing is making sure everyone continues to use the same version of the model. So, once vetted by regulators, any methodology changes will be published, and an appropriate time will be given to make the updates. The last thing anyone wants is to get to a situation where everyone is using different versions of the same model.
This all means the ISDA SIMM will continue to be a heavy lift. With the first regulatory enhancements and the first annual recalibration due next year, and with new users adopting the methodology in September 2017, there’s no time to sit back and relax. But the governance framework ISDA has put in place will ensure the necessary changes are as transparent and painless as possible.