ISDA and SIFMA published a joint paper on Initial Margin (IM) last week titled Initial Margin for Non-Centrally Cleared Derivatives: Issues for 2019 and 2020.
CloudMargin has also covered this topic in our recently published White Paper on the Seven Considerations about Initial Margin. For the benefit of our community, there are additional points in the ISDA/SIFMA paper worth summarising:
- Firms who find themselves in scope for the regulation but fail to be ready to exchange IM by their September date may find themselves unable to execute further trades, as counterparties may not wish to trade with a non-compliant counterparty
- The choice of IM model (schedule-based or risk-based) could have a profound effect on funding and trading for a firm, needing careful consideration
- Testing with custodians needs to begin in Q1 2019 to allow for the quantity of new firms in scope, and allow time to diagnose and resolve issues
- Middleware providers, such as reconciliation services, need to have readiness plans in place to take in the new firms with testing starting in Q1 2019
- ISDA is carrying out a survey to try and quantify the numbers of parties coming into scope, enabling all concerned to plan properly
- The inconsistencies between jurisdictions, and within the US (between the CFTC and prudential regulators) will cause confusion and complexity potentially leading to delays. ISDA and SIFMA call on regulators to consider making any mitigating modifications to the regulations as soon as possible to provide necessary relief
- The scope thresholds in major jurisdictions are shown here:
Initial and Variation Margin Phase-in Schedule for Major Jurisdictions
- According to ISDA, there could be 1,000 new parties in scope in the final phase (2020) resulting in 9,000 new relationships. These numbers are based on estimates by most, but not all, currently in-scope dealers. These numbers may be higher taking into account the entire market
- ISDA suggests that, given the scale of activity for 2020, firms should make an early determination on their scope (in or out) as the AANA calculations across a corporate group are themselves complex to complete. They suggest a disclosure on scope by firms 24 months in advance of September 2020, meaning September of this year
- Firms need to decide whether they put in place collateral documentation which includes their entire portfolio as in-scope for IM, or whether legacy trades (pre-compliance date) are excluded. This in turn needs disclosure to counterparties who need to cooperate with a firm’s preferred approach
Governing Documentation for VM and IM
- Firms who trade on a global basis will need to carry out an analysis of which trades are within scope for IM calculation in each relevant jurisdiction. Confusing the picture further is the real scenario that each party is subject to different IM rules (such as a US party governed by CFTC rules and an EU party subject to ESMA-EMIR rules). This may lead to exchange of “the higher of” the IM amount between either set of rules.
- Many regulators require a parallel monitoring process of margin amounts. The regulatory target is a 99% confidence level 10 day period of risk; if the amount of IM resulting from ISDA SIMM falls short of this target regulators can require additional margin amounts to be posted to cover the difference. These shortfalls must be reported to regulators and ISDA when using SIMM
- The entire market relies upon a single middleware provider to resolve IM disputes. Firms send their inputs to that provider in Common Risk Interchange Format (CRIF), which every firm will need to be able to produce. The use of a single provider means that disputes can be resolved more quickly but also that all new parties in scope need to establish connectivity for that purpose. The provider is believed to be AcadiaSoft and its Initial Margin Exposure Manager service
- With the need to post assets to cover IM, all firms will need to consider their sources of funding and eligibility schedules carefully. Whilst a fund may want to post corporate bonds, the counterparty or custodian may not be willing or able to support that request
We urge firm and fund leaders to read the industry associations’ paper to learn about the risks of not being prepared. As they see it now, many new in-scope parties could be blocked from trading OTC products if they fail to meet their September compliance date.
For help on understanding the steps to consider when aiming to comply with Initial Margin regulations, read our white paper and check out our other resources on Initial Margin here.