From March 1, thousands of financial institutions will find themselves subject to new rules that will require them to exchange variation margin on their non-cleared derivatives trades. Four weeks out, the task of meeting that deadline looks as daunting as ever. In fact, it looks a probable that many firms won’t make it, raising the prospect they’ll be temporarily unable to access derivatives markets
This might come as a surprise to some. After all, the exchange of variation margin on derivatives trades is relatively common; many counterparties already do it. The complication is that the new rules set strict requirements on everything from eligible collateral to settlement timing, and these specifications need to be reflected in counterparties’ credit support documentation
This means modifying all existing agreements or setting up new ones – a monumental task made all the more difficult by the late publication of final national rules in some cases. And it can’t be done unilaterally: changes to each credit support annex (CSA) agreement need to be agreed by the other party
That takes time. There are a couple of ways firms might make those changes, but the preferred option for many at the moment is to bilaterally negotiate the necessary changes to existing CSAs and then to use those for both legacy and new trades. Given the variability in terms within existing CSAs, and the potential pricing impact a change in terms might have on a legacy portfolio, this approach is requiring manual intervention, analysis and discussion with each counterparty. And, for the larger dealers, those discussions will have to take place thousands of times, reflecting the size of their client base and the number of CSAs they have outstanding
The good news is that the industry, supported by ISDA, has mobilized its resources to meet the March 1 requirement. ISDA has provided solutions to help compliance, including a suite of margin-rule-compliant documentation. Awareness of the issue is improving, and firms are pushing hard to meet the deadline. The bad news is that there’s a finite legal resource to negotiate the changes, both within dealers and their clients – and those resources are stretched to the limit. There are just too many documents that need to change – approximately 200,000 – and too little time
While it is possible that some of the largest derivatives users may get enough done by March 1 to continue trading, albeit with fewer counterparties, it looks like many firms will not. Without regulatory action, those users may well be locked out of the derivatives market and unable to access the liquidity they need to hedge until they’re able to agree the necessary documentation changes with their counterparties. That could result in market disruption, fragmentation and pricing impacts
We think the answer is time-limited relief to give derivatives users the crucial extra months needed to get their documents in line with the requirements. Some regulators have already taken this approach. Hong Kong and Singapore, for instance, have introduced a six-month transition, during which in-scope entities will be expected to make progress towards meeting the rules. Regulators in Australia have also opted for a six-month transition, but with a requirement for all trades executed from March 1 to be subject to variation margin requirements by September 1.
ISDA is closely monitoring implementation progress, and we’ll feed that information to regulators regularly in the run-up to March 1. Dealers and their clients will continue to pull out all the stops to make the implementation deadline, but there simply may not be enough time.