First, the good news. The number of credit support annexes (CSAs) that had been amended to meet new regulatory variation margin requirements more than doubled during the past week. The bad news is the overall proportion is still very low, at just 4.43%. With less than three weeks before deadline, it’s difficult to see how every one of the thousands of firms affected will be ready and able to continue accessing derivatives markets from March 1.
The market disruption this would cause is the reason why ISDA and a group of other trade associations, representing both buy and sell side, wrote to regulators earlier this week asking for a transition period. Under one possible scenario, the requirements would come into force as planned on March 1, but market participants would be able to continue trading while they finish their documentation updates. As with the forbearance provided by Australia in December, regulators could ask for trades conducted during that transition to be backloaded to the effective date, therefore keeping pressure on the market to amend their documents.
Seeing as most counterparties already post variation margin, this transitional period won’t lead to an increase in systemic risk. But denying a vast swath of market participants access to derivatives markets because they haven’t updated their documentation would create significant problems, with smaller end users likely the most affected. We think it’s important that all users of derivatives are able to continue to access derivatives markets to hedge from March 1 – hence the request for forbearance.
The obvious question is why progress has been so limited. The simple answer is that the legal and operational challenges of amending, replacing or executing roughly 160,000 CSAs is huge. The terms of those CSAs already in place with clients tend to be highly variable, which has required bilateral negotiations between each counterparty pair to agree the necessary changes. Despite determined efforts to get this done by the industry, supported by ISDA, the bespoke nature of many of these agreements has meant these negotiations have been complex and time consuming.
Once amended, these documents then have to be loaded into reference data systems and activated for trading. Operations staff are working hard to get this done, but the numbers are overwhelming. So far, just 12.29% of those CSAs that have been amended have been loaded up.
So, progress has been made, and derivatives users will continue to push as hard as they can. But March 1 looks extremely optimistic. As it stands, we think there is a material risk that a large proportion of firms won’t be ready. That could result in fragmentation, market disruption, higher prices and the inability for end users to put on hedges.