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Trade Associations Offer Recommendations for Derivatives Margin Phase-in

nihal.patel@cwt.com's picture
Commentary by Nihal Patel

ISDA, SIFMA, the American Bankers Association, the Global Foreign Exchange Division of the Global Financial Markets Association, and the Institute of International Bankers (collectively, the "associations") offered recommendations to regulators to mitigate potential negative impacts as initial margin requirements for uncleared derivatives are expanded to capture buy-side market participants.

Based on a recent survey performed by ISDA, it is expected that the expansion of initial margin ("IM") requirements scheduled to take place in September 2020 (referred to as "Phase 5") will result in approximately 1,100 new in-scope counterparties and 9,500 new counterparty relationships being subject to regulatory IM. The survey further found that between 26-45 percent of counterparties and 69-78 percent of relationships brought in scope in Phase 5 are unlikely to require exchange of IM at all (though the trading relationships will be subject to the rules as a whole), as they will not exceed the current EUR/USD 50 million IM exchange threshold (or similar thresholds in other jurisdictions).

Among other things, the associations recommended the following modifications in light of the survey results:

  • raising the gross notional threshold for determining when an entity is in scope for Phase 5 to EUR/USD 100 billion (from EUR/USD 8 billion);

  • removing physically settled foreign exchange products from the scope of products that count toward the gross notional thresholds;

  • exempting non-dealer counterparties from certain of the governance requirements applicable to IM models;

  • exempting non-dealer counterparties from model approval requirements; and

  • providing a sub-threshold for purposes of IM exchange, under which in-scope counterparties would not be required to establish documentation for IM compliance.

The associations' letter was directed to the Basel Committee on Banking Supervision and the International Organization of Securities Commissions, with copies provided to a number of different national regulators across the globe.

Commentary

The associations' letter appropriately focuses on suggested changes that would alleviate regulatory and compliance burdens without a materially adverse impact on systemic risk.

The recommendation for a "sub-threshold," below which IM documentation would not be required, is one that regulators should immediately adopt. It makes little sense to force market participants to establish custodial relationships and engage in contract negotiations where there is virtually no chance that margin will ever be required to be posted or collected. Where no margin is actually exchanging hands, all that is left is a compliance requirement to exchange margin at some point in the future if and when further thresholds are crossed. Whatever benefits (if any) these contingent agreements have as to systemic risk is minimal.

Other aspects of the associations' recommendations may cause more contemplation from regulators. But whether or not they adopt the particular suggestions made by the associations, regulators should recognize the virtual impossibility of a straightforward transition to Phase 5 under the rules as they are currently written.

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