It might only be November, but people already seem to be turning their minds to what’s in store for 2017. There’s likely to be a lot on the agenda, but one date looms large for the derivatives market: the March 1 implementation of variation margin requirements for non-cleared derivatives. That’s not surprising: the scale of the task is massive, and firms need to take action now in order to stand a chance of being ready in time.
Many market participants already post collateral to cover price changes on their derivatives trades, so you’d be forgiven for asking what all the fuss is about. The answer is that the rules make variation margin posting compulsory on all non-cleared trades, and set strict requirements on the type of collateral that can be posted, the frequency of the margin calls, and the required timing for settlement, among other things.
Crucially, these regulatory changes mean derivatives users will have to modify their existing collateral support agreements. And seeing as the March 1 deadline captures a broad swath of financial institutions – asset managers, pension funds, insurance companies, hedge funds – it will mean thousands of counterparties will need to change or set up thousands of agreements in a very short space of time. This will represent a repapering exercise on a scale and under a timetable never before attempted.
So, what do firms have to do to get ready? An important first step is to understand whether and when each trading relationship will be subject to margin requirements, and what rules will apply. To help with that process, ISDA has developed a self-disclosure letter that enables market participants to exchange the necessary information, covering the US, European Union, Canada, Japan and Switzerland. In order to speed up the exchange of information, this was incorporated into ISDA Amend – an online tool developed by ISDA and IHS Markit – on October 28. This is something each firm could – and should – get started on now.
The next step is to start revising and/or setting up new documentation. ISDA has now published a variety of revised credit support documents under various legal regimes, but the real challenge is how to make those changes without the grueling task of having to bilaterally negotiate with every single counterparty.
In response, ISDA has developed a variation margin protocol that will enable firms to quickly and efficiently amend existing contracts or set up new agreements that comply with variation margin requirements. The protocol was published for the US, Japan and Canada in August, and we expect to publish European Union provisions soon following publication of final European rules on October 4.
The protocol for those jurisdictions will be available on ISDA Amend later this month, which will eliminate much of the manual work of notifying counterparties and reconciling the various elections made. Once that is up and running, market participants will have a little more than three months to onboard all their counterparties.
The timeline is even more challenging for those jurisdictions that have yet to publish final rules. In an article published in Risk recently, I estimated it would take four and half months to develop a protocol and build it into ISDA Amend from the point the rules are finalized. If regulatory timelines don’t allow for the building of an automated industry solution, then firms will have to bilaterally negotiate changes with each counterparty – a hugely time-consuming and resource-intensive task.
Even with the protocol available, the variation margin deadline will pose a massive challenge for the industry. Over the past two months, we’ve held a series of conferences across the globe focusing on the margin rules. The comments from those who attended made clear that many firms are seriously worried about their capacity to agree the necessary changes with every one of their counterparties.
The message is very clear: start to prepare for March 1 now. Understand what the rules will mean for you; look at your outstanding contracts; and start getting in touch with your counterparties. Any firm that leaves it much longer may find it is unable to trade from March 1.