Now is the Time to Think About Benchmarks

With everything going on – implementation of MIFID II, Brexit negotiations and publication of the latest Basel measures – it’s difficult to look too much beyond 2018, let alone the end of 2021. That’s the date Andrew Bailey, chief executive of the UK’s Financial Conduct Authority, has said the regulator will no longer compel or persuade banks to make submissions to LIBOR (although panel banks have agreed to submit until then). But the task of transitioning from the IBORs to new risk-free rates (RFRs) is immense, and the industry can’t afford to kick the can down the road. Everyone needs to start thinking about what this means for them now.

There has been progress. Public-private sector working groups in the US, UK and Japan have already settled on their choice of RFRs, and have begun planning for transition. Europe also now has its own working group of public- and private-sector participants to consider the issue. But there are a whole host of challenges that need to be thought through by the industry – from dealing with possible value transfer and potential liquidity issues, to the requirement by certain investors for term fixings and the possible regulatory and capital implications of switching legacy trades to alternative RFRs. The scale of the task, both in terms of volume of outstanding contracts and the breadth of sectors affected, is unprecedented.

ISDA has decided to think about these issues now. Last month, we announced that we’re working on a comprehensive report that will consider how the IBORs are currently used across financial markets, including in derivatives, loans, bonds and mortgages. It will highlight likely challenges in any transition, and outline identified solutions. Central to the report will be global survey of buy- and sell-side firms, trade associations and infrastructure providers that will take place either side of the holidays.

The intention is to build on the work being done by the various public-private sector working groups, and to consider the issues on a global basis. We’re not saying this report will have all the answers – but it should at least identify the main issues and possible solutions. If you’re closely involved in benchmarks at your firm, then we would value your input.

Separately, work is continuing on an initiative to develop robust fallbacks for certain key IBORs. These two projects are often confused – which isn’t surprising as the issues and challenges are similar. In short, if the RFR initiatives are about encouraging a managed, orderly transition to RFRs with a possible deadline of end-2021, then the fallback work is meant to address what would happen for anyone yet to transition their positions if an IBOR ceases to be published as certain trigger events occur. Having a clearly defined fallback plan written into contracts will help minimize any disruption this might cause.

The ISDA working groups considering the issue have proposed using the relevant RFRs identified by the public-private sector initiatives where they are available. But many of the same challenges facing the transition work have emerged here too – how to minimize value transfer, how to treat the absence of term fixings, how to deal with the fact the IBORs reflect bank credit risk while RFRs do not.

The two initiatives are closely coordinated – many of the same participants, including ISDA, are involved in both. But the two are working to different timelines – a possible end-2021 date for transition, and ASAP for fallbacks. That could mean the solutions developed to address these challenges for fallbacks may differ to the solutions established for transition. All this is taking place against the backdrop of the European Union Benchmarks Regulation, which requires supervised entities to produce plans from January that set out the steps they will take in the event a benchmark ceases to be published. ISDA is currently working on a supplement to help participants meet this requirement.

ISDA will keep the industry updated on all of these initiatives throughout 2018. That’s when we expect the rubber to really hit the road, and for the challenges and solutions to be fleshed out. But market participants shouldn’t wait to start thinking about how a shift from the IBORs will affect them. Now is the time for each firm to comprehensively identify how they use the IBORs – to what extent is an IBOR-referenced rate paid or received on loans, bonds or derivatives, and to what degree is it used as a discount rate to determine liabilities? Only armed with this information will firms be in a good position to meet the challenges faced by these changes.


Monitoring of Basel Rules will be Critical

Publication of the latest package of capital requirements – often dubbed Basel IV – has been a long time coming. A year later than expected after a disagreement between European and US regulators over the level of an output floor, banks finally have clarity on the detail of the final framework.

There was little surprise about the output floor compromise – the 72.5% level was widely flagged in the media in advance. It remains to be seen whether this figure will ultimately mitigate the concerns of those European regulators who were worried about a reduction in risk sensitivity in the framework.

An impact study from the European Banking Authority (based on end-2015 data) indicated total Tier 1 minimum required capital would increase by 15.2% for European Union global systemically important banks (G-SIBs) on a weighted average basis. That compares with an average drop of 1.4% for G-SIBs globally, according to figures from the Basel Committee on Banking Supervision. However, that global figure masks a wide variation in impact, meaning there will be winners and losers. The Basel Committee estimates the total capital shortfall for G-SIBs is €85.7 billion.

Fortunately, there’s time to drill down closer into the impact, and to ensure those banks most active as intermediaries aren’t forced to pull back from providing liquidity. The Basel Committee has set out transitional arrangements that will enable the floor to be phased in over five years, and the clock starts counting down in 2022. Implementation of other parts of the framework will also occur in 2022.

This timing is important. Since the crisis, the largest global banks have raised over $1.5 trillion in new common equity Tier 1 capital. Further changes need to be very carefully monitored during the period until implementation to ensure capital levels don’t rise significantly and become out of synch with risks and returns. That would impact the ability of banks to provide financing, investment and risk management services to the real economy. Where anomalies are spotted, regulators must act to adjust the framework to the extent necessary.

This monitoring should also drill down to the business and product level. While a specific change may have a relatively muted effect on overall bank capital, the impact on a particular business can be much more severe. As a result, banks are more likely to pull out those businesses that are deemed uneconomic.

Take the leverage ratio as an example. Banks are required to count customer cash collateral held at central counterparties towards their leverage exposure and to ignore the exposure-reducing effect of initial margin. This has a negligible effect on overall bank capital, but it significantly increases the amount needed to support client clearing activities. Some banks have opted to scale back or withdraw from the client clearing business as a result, which runs counter to the objectives of the Group-of-20 nations to encourage central clearing.

While the Basel Committee has said it will continue to monitor the impact of the leverage ratio on client clearing, it is disappointing that the requirement has been left unchanged in the final package. National regulators and policy-makers such as the US Treasury and the European Commission have recognized this as an issue, and have already proposed alternative treatments. We think it’s important for the calibration to be globally consistent to prevent regulatory fragmentation and an unlevel playing field.

There were some welcome inclusions. There is a commitment to review the calibration of both the standardized and internal model approaches of the Fundamental Review of the Trading Book, and the implementation date is being extended to 2022. This will give regulators and the industry time to further develop new and largely untested elements, like the new eligibility test for trading desks to use internal models and the non-modellable risk factors framework, and to ensure the calibrations are appropriate. The credit valuation adjustment framework has also been recalibrated – although the new requirements should be fully tested before implementation to ensure the rules are proportionate and sensitive to risk.

Over the coming weeks, ISDA will work with members to review the entire text in detail. In the coming year, we will also provide input and impact analysis as national authorities look to transpose the rules into local regulation. ISDA is committed to ensuring we have a capital framework that is both safe and efficient.

No End to ISDA SIMM Work

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.

Margin Rules: Lessons Learned

It’ll probably come as no surprise that one of the major preoccupations for ISDA and many of its members over the past week has been the implementation of non-cleared margin requirements. On September 1, 20 or so of the largest derivatives users began exchanging initial and variation margin on their non-cleared trades under rules that took effect in the US, Japan and Canada. Barring some teething problems, the rollout went relatively smoothly given the scale of the change and the time given to the industry prepare for it. However, we won’t be stopping here – we know there is plenty more work to be done.

September 1 preparations went to the wire, with many firms working to sign the relevant documentation with their counterparties right up to the start date. Some were unable to set up custody accounts for all of their counterparty relationships for September 1. Banks were also waiting until the end of August for clarity on whether they had approval to use the ISDA SIMM.

This largely boils down to time. Final rules from domestic regulators were needed for the industry to finish drafting new credit support annex (CSA) agreements, and to implement, test and seek regulatory approval for initial margin models. The magnitude of the changes meant market participants didn’t have much time to get it all done. Final rules from US prudential regulators were the first to emerge a little more than 10 months ago, with Japanese regulators publishing theirs at the end of March.

Preparations were further complicated by news that European regulators wouldn’t have their rules ready in time for a September launch – with Australia, Hong Kong, India and Singapore subsequently following its lead to defer the start date until next year. The split in what had been a globally coordinated implementation timetable created new cross-border and compliance headaches.

Adding to this complexity was the absence of a substituted compliance determination between US and Japanese rules (the Commodity Futures Treading Commission is set to vote on whether Japanese rules are equivalent today – a week after the rules went live).

Given this, what ISDA and its members have achieved is nothing short of staggering. For the first time, the industry has developed and agreed to a common, transparent model to calculate initial margin on non-cleared derivatives – the ISDA SIMM. A new set of industry standard documents has also been drafted and published in record time, setting out the process for exchanging variation margin and initial margin under various legal regimes. (A summary of ISDA’s various initiatives is available here.)

There are, of course, lessons to be learned from the September 1 implementation. The most obvious is that it takes time to put these changes into effect. Adapting or agreeing new collateral agreements and setting up custody accounts for every in-scope counterparty relationship cannot be completed in a matter of weeks. While only 20 or so entities were caught by the first-phase implementation in the US, Japan and Canada, it required negotiation or revision of hundreds, if not thousands of documents for their various subsidiaries.

This is particularly relevant as European and other regulators look to finalize their rules and set a new time frame for implementation.

We are mindful of the challenges in implementing the rules, and we will work with regulators and market participants to make them aware of how these deferred phase-one rollouts will impact the ‘big bang’ launch of variation margin requirements, which apply to all entities under the scope of the rules from March 1, 2017. The near-simultaneous rollout of deferred phase-one and variation margin requirements could seriously test implementation capacity.

We’d like to see certainty in the timeline for all jurisdictions, alongside a realistic implementation window for deferred rollouts. Equally important is the need to ensure market participants fully appreciate the scale of the task ahead of them in preparing for implementation. ISDA will continue to play a central role in informing members about these requirements and providing the tools to help firms comply. We’ll also continue to monitor the ISDA SIMM via a transparent governance framework to ensure it meets industry and regulatory requirements.

ISDA will be focusing on this issue at our regional events in the coming months. Our New York conference is next week, so we hope to see you there. Click here for more information.

Resolution on CCP Resolution?

The Financial Stability Board (FSB) and its chairman, Mark Carney, last month reiterated their intention to prioritize central counterparty (CCP) resilience, recovery and resolution for the remainder of 2016. They are absolutely right to focus on this issue. Several clearing houses have become systemically important as a result of global clearing mandates, and it’s vital this infrastructure is as secure as possible – which means establishing a credible and robust recovery and resolution framework.

This isn’t a new topic, of course. Considerable thought has gone into this at both the regulatory and industry level over the past few years – and ISDA has published several papers on the issue (here’s our most recent). But the thinking is continually evolving, particularly on the issue of resolution. An important recent consideration has been when and how recovery becomes resolution – in other words, at what point should resolution authorities step in, and what tools will be available to them?

It’s a crucially important issue. At ISDA, we recognize there may be situations where a resolution authority has to intervene before CCP-led recovery efforts have fully run their course. That might include circumstances where it is felt the recovery measures set out in the CCP rule book would further increase systemic risk or lead to contagion. But, if resolution authorities elect to enter a CCP into resolution, we believe it is important to abide by certain conditions to maximize certainty and predictability and maintain market confidence.

In particular, we recommend that resolution authorities, should they intervene, follow the rules and the tools defined in the CCP rule book. ISDA has already set out a proposed recovery framework, which includes a variety of loss-allocation and position-allocation tools and the sequence of their use, aimed at providing maximum predictability of outcomes. We recommend this framework be adopted in CCP rule books, approved by regulators and followed by resolution authorities. By following this transparent rule book, a resolution authority would provide comfort to market participants and minimize market disruption, as well as ensure the concept of ‘no credit worse off’ – a central element of the ISDA recovery framework – is applied.

Careful thought should also be given to the point of entry. ISDA believes recovery should be CCP-led as far as possible, but if that is not possible, the indicators for a resolution authority intervention should be defined upfront. Clarity over the entry point would, again, help provide certainty about the process.

It’s important, though, that these triggers aren’t automatically applied. For instance, it’s possible one of the conditions for intervention might be failure by the CCP to achieve a matched book. However, it’s also possible the problem is limited to a small subset of illiquid products. In that case, it might be preferable for the CCP to implement position-allocation tools for that subset, such as partial tear-up, rather than trigger resolution of the entire CCP.

There’s another important element to all of this. Whether through recovery or resolution, clearing participants should be compensated for any losses incurred through loss-allocation or position-allocation tools, over and above the CCP’s funded and unfunded default resources. This emulates the outcome that would be achieved if clearing participants were to go through an insolvency process.

All of this comes back to CCP resiliency. Ensuring CCPs are strong to begin with minimizes the prospect of a recovery or resolution action. That’s why the measures outlined in our paper on CCP resilience – transparency, stress testing, appropriate skin in the game, monitoring of concentration risk and scrutiny of suitability of products for clearing – are vital.

In making these proposals, ISDA is continuing in its long-standing role of ensuring legal and contractual certainty for industry participants, and in helping to build reliable and transparent procedures to deal with periods of market stress. Both the FSB and European regulatory authorities are due to publish further proposals on CCP soundness in the coming months, and ISDA will continue to engage with its membership, the wider industry and all relevant regulatory institutions to ensure the best solution on this issue.

Infrastructure Investment

Speak to anyone who knows a thing or two about the infrastructure that the modern world is built on – roads, rail, power generation and supply, etc – and they will tell you that often the biggest obstacle to its improvement is the ‘legacy’ issue. Once a system is in place, built at great cost and effort, transitioning to improved technology can be challenging.

This is a headache that the derivatives market now faces. Much of the infrastructure used in the handling of data, the processing of documentation, the execution and confirmation of trades and the exchange and management of collateral, is over-complex, needlessly duplicative and inconsistent.

Let’s face it – old systems were developed for old problems. With the financial reforms at various stages of implementation, our members are looking for new solutions to automate and streamline the massive reporting, trading and clearing requirements and new collateral management requirements in the derivatives space. To support our members and address the operational challenges and complexity head on, ISDA itself has reorganized its working groups to focus on developing solutions for critical infrastructures that are now embedded in the fabric of the derivatives market. For instance, we see tremendous potential to move collateral management from faxes, email and Excel spreadsheets to a more automated and streamlined process.

ISDA is in an ideal place to help guide this change. At our core, we are a standards body. We have brought the market together to establish the ISDA Master Agreement and the ubiquitous Credit Support Annex (CSA). Today, we are leading the market to bring a standardized approach to non-cleared margin rules with the ISDA Standard Initial Margin Model (SIMM). We are developing new CSAs to comply with the updated segregation requirements, and we are putting together a globally-applied resolution stay protocol to harmonize resolution regimes. Looking ahead, there is an opportunity to future-proof the legal documentation process through smart contracts, and to develop industry operational standards to facilitate the processing of trades throughout the trade lifecycle. Additionally, so much more can be done to modernize and upgrade the process by which we exchange collateral by driving standardization and automated efficiency.

ISDA has canvassed its members on these issues, and turned their proposals into a whitepaper that will lay out some proposed steps toward reform. We have been engaging with members and fintech / regtech firms to identify problems and recommend solutions. To give you a preview, our paper will focus on three specific areas.

  • Data: Agreement on formats and identifiers would significantly benefit market participants and regulators. In particular, a robust, granular, multi-use product identifier with strong governance on an open-source infrastructure would remove many systemic inefficiencies and further promote transparency.
  • Documentation: Despite a plethora of standard documents published for industry use, it is an unfortunate fact that many documents are still customized between transacting parties. The benefits of this customization are now being questioned, and there are opportunities for further standardization to drive more efficient processing, both within firms and across the market. We are committed to future-proofing the essential ISDA documentation through ‘smart contracts’ that will facilitate the automation strategies being developed by distributed ledger and block chain firms. ISDA has a lot to offer to speed the adoption in this space.
  • Duplication: There is a huge opportunity to cut down on the complexity and multiplicity of business processes required to support the same functions within or across asset classes. Standard processing models can facilitate the extension of Financial products Markup Language (FpML) in order to remove cost and inefficiency and provide a solid base for further evolution.

This isn’t about levelling existing infrastructure and starting from scratch. It is about finding a more efficient, less costly way of operating vital processes, and making sure that new, beneficial technology can be brought to bear without adding further burdens to an already over-stressed system.

ISDA will continue to encourage and facilitate discussion on these issues among traditional and new operators in the derivatives market. Our membership is exceptionally broad, and our door is always open to new firms and new ideas. This is a challenge that will be overcome, above all, by cooperation and collaboration, and ISDA will always provide a platform for this to take place.

Change Leverage Ratio’s Tax on Risk Management

Brexit may have overshadowed events over the past month, but it doesn’t mean everything else has just stopped. A huge amount of work is ongoing, from preparations for forthcoming margining requirements to flagging new straight-through processing rules. The capital space has been particularly busy with nine consultation responses filed in a matter of weeks, covering topics from internal models to the net stable funding ratio.

Our response to the Basel Committee on Banking Supervision’s consultation on the leverage ratio was one of the most recent. In it, we reiterate our concern about the impact of the leverage ratio on client clearing. This is an important topic, not least because the Group-of-20 specifically wants to encourage more clearing.

At its heart, the issue is fairly simple: we believe segregated initial margin posted by clients is not a source of leverage for banks, as it cannot be used to fund their operations. Rather, it is meant to cover any losses by a defaulting client – in other words, client initial margin is intended to reduce the exposure related to a bank’s clearing business. Despite this, the leverage ratio doesn’t currently recognize this exposure-reducing effect, which means the capital required to support this business is unnecessarily high. This makes the economics of client clearing more challenging for clearing-member banks.

Importantly, the Basel Committee said when launching its consultation in April that it would collect data to study the impact on client clearing – a step we welcome. ISDA has already pulled together some preliminary information, which indicates that not recognizing client initial margin has a significant effect on the leverage ratio exposure of client cleared transactions. This data will be further developed and submitted to the Basel Committee.

But it’s not just cleared transactions that are affected by this. A similar argument applies to bilateral non-cleared trades: segregated initial margin posted by customers should mitigate exposure, as it is intended to cover the losses racked up by a defaulting counterparty.

ISDA supplied data on this segment too, in response to a request from the Basel Committee for information on bilateral derivatives with counterparties. This issue will become increasingly important – and will have an increasingly large impact on capital requirements – as margining rules for non-cleared derivatives are rolled out.

Under those rules, initial margin has to be segregated and – like collateral posted for cleared transactions – cannot be used by a bank as a source of leverage. Exact requirements differ from jurisdiction to jurisdiction, but they all strengthen the protection given to initial margin, and ensure it is segregated from the margin collector’s proprietary assets. For example, under final margin rules published by the US Commodity Futures Trading Commission, initial margin must be held by a third-party custodian to ensure it is available to the non-defaulting entity in the event of a counterparty default. The custodian – which cannot be affiliated to either counterparty – cannot rehypothecate the margin.

Given this margin cannot be used as a source of leverage, and is intended to mitigate exposure, we believe initial margin received should be recognized as exposure-reducing in the leverage ratio calculation.

We very much welcome the fact the Basel Committee has reopened the leverage ratio for consultation – that kind of flexibility is important when regulators are implementing new rules virtually from scratch. We hope the points we raise will be considered and that the leverage ratio is made stronger as a result.

Read our response to the leverage ratio consultation by clicking here.

Brexit – Two Weeks On

Like many people, I woke up on Friday June 24 expecting to hear the UK had voted to remain in the European Union (EU). The final polls had suggested the Remain campaign was ahead, and sterling had begun to rally the day before. A prominent member of the Leave campaign had all but conceded late on the Thursday night. As I went to bed, early results from Gibraltar and Newcastle were in favor of remaining. Like many people, regardless of how they voted, I was therefore caught by surprise when I switched on morning news.

The vote by the UK to leave the European Union (EU) is a momentous event, and will have significant ramifications on the political, economic and financial landscape in both the UK and the EU. In the immediate aftermath, financial markets have been volatile, and the political fallout severe. Two weeks after the vote, there is considerable uncertainty about the ultimate form of any negotiated exit.

But there are some things we already know for sure. For one thing, the UK continues to be part of the EU, and will remain a member for some time yet. Once the UK government serves formal notice of its intention to withdraw via Article 50 of the Treaty on the Functioning of the European Union, it will have at least two years to negotiate a settlement. During that time, existing European regulations and treaties will continue to apply – as this statement from the UK Financial Conduct Authority makes clear.

We also know that the referendum vote to leave the EU will not, by itself, have any immediate consequences on the legal certainty of derivatives contracts, nor will it require any contractual change. Nothing will fundamentally change in the immediate term. That’s not to say derivatives users shouldn’t begin to consider future implications. To help with this process, ISDA has published analysis that highlights potential issues that counterparties will need to consider, including the impact on the choice of English law as the governing law for an ISDA Master Agreement.

Now the UK has voted to leave, ISDA will convene applicable working groups and hold a series of industry calls to ensure market participants are prepared for future developments. The first of those calls took place last week, in partnership with law firm Linklaters. This webinar briefing set out issues touching on passporting rights, the impact on clearing, trade reporting and margining, and legal and documentation. Close to 4,000 people listened in.

The overriding message was that little will fundamentally change in the near term: those UK firms subject to the European Market Infrastructure Regulation (EMIR) and the forthcoming revised Markets in Financial Instruments Directive and regulation will continue to have to comply at the moment. However, the implications post-Brexit will depend on the exit model that is agreed between UK and EU authorities at the end of the two-year negotiation period. That will determine whether, for example, passporting arrangements will continue to apply, and whether EU entities subject to the clearing obligation under EMIR will be able to clear through UK central counterparties.

ISDA’s top priority is to work with UK and EU authorities – as well as other affected jurisdictions – to resolve any cross-border differences and harmonize rule sets. Our goal is to ensure that we have consistent regulation to support deep pools of liquidity and risk management for our membership.

It is clear there is a lot of work to do in the months and years ahead. There is a lot of uncertainty. It’s vitally important we have a deliberate and organized process to provide financial, legal and operational certainty going forward.

For more information:

ISDA webinar on Brexit

ISDA analysis on implications of Brexit

ISDA statement on referendum vote

Unity Needed on Margin Timetable

Harmonization and coordination are easy enough to identity as objectives, but harder to achieve. Regulators can take a lot of credit, then, for their efforts to develop a coordinated global margining framework for non-cleared derivatives. As part of that, each national regulator agreed to adopt the same implementation schedule, setting a start date of September 1 for the biggest banks.

That carefully orchestrated timetable is now splintering. Earlier this month, a European Commission (EC) spokesperson confirmed that European rules would not be finalized in time for the September launch. European authorities will instead aim to deliver final standards by the end of the year, pushing the start date in Europe to the middle of 2017. As it stands, no other jurisdiction has followed suit – in fact, press reports suggest other regulators are holding firm.

We believe it’s positive that European regulators spend the necessary time to ensure their rules are appropriate. But the split in timing poses some important questions. Under the globally agreed timetable, implementation would be phased, starting with the biggest banks exchanging initial and variation margin from September 1 – known as phase one. The next major deadline is March 1, 2017, when the variation margin ‘big bang’ becomes effective for all covered entities – not just banks, but other financial institutions, including the buy side.

It is understood that European phase-one banks will now not be required to comply with margining requirements until the middle of next year – unless they are trading with phase-one banks still subject to margin rules in other countries. Presumably, that means the March 2017 variation margin big bang deadline will also be pushed back in Europe. That will have a far wider, and far more profound impact on cross-border trading.

Clarity on this point is important from a readiness and operations standpoint – as is clarity on how other regulators will approach the March 2017 deadline.

The implications of a fractured timetable are complex enough for the big phase-one banks. On the face of it, the delay creates an unlevel playing field – but the precise impact will depend on the status of each entity and the identity of their counterparties.

The complexity will increase exponentially once variation margin rules come into effect in March, when more derivatives users will be subject to collateral posting requirements. It will also lead to greater fragmentation and disruption of cross-border trading. If other regulators retain the March 2017 deadline and Europe does not, then it might encourage European market participants to trade with European dealers where possible.

Given the impact from March 2017 on the broader market, not just the largest banks, it’s important this issue is considered carefully. There is an easy answer: realign the global implementation deadline. We would urge regulators to do that in the interests of ensuring the market can continue to function efficiently.

Measure Twice, Cut Once

Last week, I was fortunate enough to be invited once again to testify before the House Committee on Agriculture’s Subcommittee on Commodity Exchanges, Energy, and Credit on the impact of new capital and margin rules. This came at an extremely opportune time. Margining requirements for non-cleared derivatives will be rolled out for the largest banks from September, while core elements of the Basel reforms are still evolving.

The problem is that no one has a clear idea of how these various rules will interact and what the ultimate impact will be.

As I said in my testimony, the old tailor’s saying holds true – measure twice, cut once. At the moment, we’re cutting our cloth in the dark.

What we do know for sure is that policy-makers such as the Group of 20 and the Financial Stability Board think further refinements to Basel III should be made without significantly increasing capital across the banking sector. Major improvements have already been made to ensure the financial system is more robust. As I pointed out last week, common equity capital at the largest eight US banks has more than doubled since 2008, while their stock of high-quality liquid assets has increased by approximately two thirds.

Unfortunately, recent studies by ISDA on those parts of the capital framework that have not been fully implemented show further increases in capital or funding requirements for banks, on top of current levels. This will increase costs for banks, and may negatively impact the liquidity of derivatives markets and the ability of banks to lend and provide crucial hedging products to corporate end users, pension funds and asset managers.

Given this, ISDA believes regulators should undertake a comprehensive impact assessment covering capital, liquidity and margin rules. Given continuing concerns about economic growth and job creation, legislators, supervisors and market participants need to understand the cumulative effect of the regulatory changes before they are fully implemented.

The margin rules are equally important – and we’re rapidly approaching the September effective date for the large, phase-one banks. ISDA has worked hard to prepare for implementation, by drawing up revised margin documentation that is compliant with collateral and segregation rules and developing a standard initial margin model called the ISDA SIMM.

But despite these efforts, challenges remain. For one thing, regulators need to send a clear signal that the ISDA SIMM is appropriate, giving banks the confidence to implement the model ahead of the start date.

For another, the Commodity Futures Trading Commission needs to finalise cross-border margin rules to ensure substituted compliance determinations can be made for overseas rules that achieve similar outcomes. These determinations need to be made quickly. Another three-year wait, as happened with the US/EU central counterparty equivalency standoff, will hobble cross-border trading and further contribute to the fragmentation of global derivatives markets.

I would just like to take this opportunity to thank the House Committee on Agriculture for its interest in these topics, and for holding this important hearing.