Beware the Code Freeze

Europe has picked up the pace of its approval process for rules on the margining of non-cleared derivatives. The latest thinking is that the European Parliament will wrap up its non-objection this month, prompting the market to reassess the likely date the rules will come into force. Depending on what the Council of the European Union (EU) does, it’s possible the largest EU phase-one banks could be posting initial and variation margin from early January.

We welcome the push to harmonize implementation schedules with those in the US, Japan and Canada. The margin requirements were originally intended to be rolled out according to a globally consistent timetable – a plan we supported. That fell by the wayside when the European Commission announced in June it would delay its rules until 2017 – a move that was later followed by Australia, Hong Kong, Singapore and India. So, we think realigning Europe with the US and others as soon as possible is a good thing.

There is a fly in in ointment, though. Many banks enforce an end-of-year code freeze that prevents them from making any changes to systems and models. Introducing far-reaching margin rules during this freeze could pose risks. Worryingly, it could hamper the ability of banks to make fixes to newly installed collateral systems and processes if something goes wrong.

We think a mid-January implementation for the EU would be safer from an industry perspective. Those few extra weeks would mean the code freeze would be finished and any emergency IT fixes that need to be made can be made.

Go too far beyond mid-January, however, and we start approaching another hurdle: the March 1, 2017 rollout of variation margin requirements. This deadline will affect a much wider universe of firms, and will involve thousands of counterparties having to make changes to thousands of outstanding collateral agreements at once. This on its own will pose major resource issues for the industry. If combined with the delayed European phase-one requirements, it could stretch capacity to breaking point.

So, we’re probably looking at a window of between mid-January and early February for the European rules to come into force. That gives enough time to get past the code freeze, but means there’s a tiny bit of breathing space before the variation margin requirements are introduced. We think this gives the best chance for the margin rules to be implemented in Europe without disruption.

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