Global regulators may have missed a rare opportunity to create unified global rules for collateralisation of over-the-counter derivatives trades that are not cleared by central counterparties, leading to asymmetric requirements that market participants are struggling to manage ahead of the September 2016 implementation date.
“Margin rules seemed to be a real opportunity for global regulators to truly have a single rule,” said Keith Bailey, managing director for market structure at Barclays, speaking on a panel at ISDA’s Annual General Meeting in Tokyo.
Among all new regulations stemming from the G20 requirements, uncleared margin is unusual in that it comes into effect globally on the same day.
“Uncleared margin has been professed by global regulators as a poster-child for a coordinated effort but it was probably too high an aspiration to think that we might have ended up with a unified rule,” said Bailey.
“Part of that comes from the varying statutes that regulators have to comply with, themselves having different definitions of derivatives.”
He also notes that precedents have been set from clearing rules that have created certain waivers and exemptions. For example, in the US, commercial end-users may not have to clear a trade if it is for hedging purposes.
“Once you have that in the clearing rule, you can’t really have a different circumstance in the uncleared rule,” said Bailey.
There are also some differences with regard to product scope. For example, equity options are in scope for the European rules, although with delayed implementation, while they are not included in US rules.
Settlement times can vary, with many jurisdictions requiring T+1 settlement, while some cross-border trades, particularly in Asian jurisdictions, can see settlement extended to T+3.
Standard model
The new rules are set to go live for the largest derivatives users on September 1, with others following in waves out to 2020. All counterparties will be required to exchange daily variation margin on those transactions from March 2017.
ISDA has worked with industry participants to develop its standard initial margin model that should enable counterparties to slash the amount of high-grade collateral required to hold against their bilateral swaps exposures.
Speaking on the panel, Tomo Kodama, managing director at Bank of America Merrill Lynch, presented a set of processes for margin calculation, beginning with accurate matching of trade populations between counterparties. Exempt transactions such as physically settled FX then need to be removed before remaining swaps are bundled into asset classes. Counterparties are required to input sensitivities such as DV01, issuers and trade terms.
“The really important thing is that this all gets done in time to go into the calculation to get the margin numbers,” said Kodama. “The SIMM tries to standardise the process to make it as easy as possible to get everything done in time for the 7am calculation.”
Recent publication of new margin rules by global regulators has left limited implementation time. In Europe, for example, final rules are still awaiting approval from European Parliament, which has three months to provide the green light and a number of MEPs have already raised some queries.
With tight deadlines, market participants warned derivatives users to begin the implementation process immediately, regardless of their phase-in date.
“Even if your phase-in date is further out, you really need to be thinking about getting legal documents in place as there are long lead times on some of this,” said Ciaran O’Flynn, EMEA head of bank resource management at Morgan Stanley.
“Counterparties need to think about connectivity as in today’s markets there are so many regulatory things coming down the pipe [for which] you really need to secure IT resources.
Many participants view uncleared margin rules as one of the biggest changes in the derivatives industry stemming from G20 agreements and panellists agreed that it would have a significant impact on volumes and notionals in the uncleared derivatives market.
“The pendulum is definitely swinging. Today, clearing is expensive but uncleared is free from an initial margin perspective. Under the new rules, uncleared swaps will be markedly more expensive and over the next 18 months I imagine you will have the opportunity to clear a broader range of products,” said Barclays’ Bailey.
Pushing more swaps into central clearing was a clear intention of global regulators when writing new rules, but panellists remain unsure about the extent of that shift towards more standardised and cleared instruments.
“We know the direction of travel. How much, how soon and how fast is anyone’s guess,” said O’Flynn. “We’ll probably see reduced activity as a function of fractional costs such as novations getting harder. Things are probably going to get a little slower and a little more complex.”