Margin Rules: Lessons Learned (by Scott O’Malia, ISDA)
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.
Temporary equivalence is set to expire on June 30 2022.
IRS trading volumes have fragmented without an equivalence agreement.
Phase 5 of the uncleared margin rules came into effect on 1 September.
Triparty repos can be executed across U.S. Treasury securities to central clearing.
CEDX opened on 6 September, offering contracts on Cboe Europe single country and pan-European indices.