Regulators Zero In On Margin

Terry Flanagan

International securities regulators are seeking to establish standards for margin and collateral requirements for OTC derivatives that are not cleared through a central counterparty (CCP).

The Basel Committee on Banking Supervision (BCBS) and the International Organization of Securities Commissions (Iosco), in a consultation paper on margin requirements for non-centrally-cleared derivatives released last month, are proposing that all financial firms and systemically-important non-financial entities that engage in non-centrally-cleared derivatives must exchange initial and variation margin as appropriate to the risks posed by such transactions.

“They are increasing the margin requirements for non-cleared products,” said Zohar Hod, global head of sales and support at SuperDerivatives, a provider of cloud-based derivatives data, technology and valuation services for the financial and commodity markets. “They’re guidelines, not mandates. So each CCP will choose its own way of charging margin. And dealers will be allowed to charge more margin than what the CCP requires.”

In the United States, the Securities and Exchange Commission has proposed capital, margin and segregation requirements for security-based swap dealers and major security-based swap participants.

Under the Dodd-Frank Act, the SEC must impose margin and capital requirements to help ensure the safety and soundness of security-based swap dealers and major security-based swap participants.

The margin rules are required to be appropriate for the risk associated with security-based swaps that are not cleared by a security-based swap clearing agency.

“We have been approached by numerous buy-side and sell-side institutions to help them address upcoming challenges related to the calculation of initial margin and variation margin for their portfolios of cleared and uncleared derivatives transactions,” said Kevin Gould, president of Markit, in a comment letter.

Markit provides analytical services across asset classes, often in conjunction with its pricing and valuation services, which support banks with the calculation of measures such as CVA (credit valuation adjustment).

The Commodity Futures Trading Commission has proposed corollary capital and margin rules, and has also adopted segregation requirements for cleared swaps and proposed segregation requirements for non-cleared swaps.

The proposed Iosco/BCBS requirements would allow for the introduction of a universal initial margin threshold of €50 million. The results of a quantitative impact study (QIS) conducted in 2012 indicate that application of the threshold could reduce the total liquidity costs by 56% relative to a margining framework with a zero initial margin threshold, which was initially proposed in the July 2012 consultative paper on margin requirements for non-centrally-cleared derivatives.

The proposal envisages a gradual phase-in to provide market participants with sufficient time to adjust to the requirements. The requirement to collect and post initial margin on non-centrally cleared trades is proposed to be phased in over a four year period beginning 2015 and begin with the largest, most active and most systemically risky derivative market participants.

The International Swaps and Derivatives Association (Isda), a trade body, has introduced a standardized credit support annex (CSA), based on overnight indexed swaps (OIS) discounting, in order to accelerate the trend toward a more accurate method for pricing OTC interest-rate swaps.

An OIS is an interest rate swap where the periodic floating rate of the swap is equal to the geometric average of an overnight index (i.e., a published interest rate which is also called overnight rate) over every day of the payment period. The index is typically an interest rate considered less risky than the corresponding Libor interbank rate.

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