Two regulatory standards bodies have jointly released new guidance on forthcoming initial margin requirements including direction for legacy derivative contracts transitioning to new benchmarks.
The Basel Committee on Banking Supervision (BCBS) and the International Organization of Securities Commissions (IOSCO) published guidance this week on the preparation for exceeding the framework’s €50 million initial margin threshold and the amendment of derivatives contracts in response to interest rate benchmark reforms.
In its update, the bodies said amendments to legacy derivative contracts pursued solely for the purpose of addressing interest rate benchmark reforms do not require the application of the margin requirements for the purposes of the BCBS/IOSCO framework.
The industry is currently transitioning away from Libor and other Ibor benchmark rates.
The statement added that covered entities should also act diligently when their exposures approach the €50 million initial margin threshold to ensure that the relevant arrangements needed are in place if the threshold is exceeded.
Trade association SIFMA welcomed the guidance, but added: “We believe further action is needed, however, to avoid disruption to the functioning of the derivatives market and we urge regulators to lift the phase five threshold and remove physically settled FX from the calculation.”
In the EU, initial margining requirements for bilateral OTCs began to apply in September 2016 as part of the European Market Infrastructure Regulation (EMIR). It initially impacted any financial institution with an average aggregate notional amount in excess of €3 trillion in OTC contracts, although this was reduced to €1.5 trillion in September 2018.
As of September 2019, that threshold will drop down to €750 billion before settling on €8 billion in 2020, an amount which is broadly synchronised with other major markets.
Despite the regulation’s positive intentions, the initial margin thresholds have invoked criticism. The International Swaps and Derivatives Association (ISDA) along with other industry bodies including SIFMA, the American Bankers Association (ABA), the Global Foreign Exchange Division of the Global Financial Markets Association (GFMA) and the Institute of International Bankers (IIB) have called for a recalibration of the proposed final initial margin thresholds, asking that they be raised from EUR/USD 8 billion to EUR/USD 100 billion.
“The sentiment is that the EUR/USD 8 billion threshold – currently proposed by regulators – will impact a lot of financial institutions and counterparties yielding very limited overall benefits,” said Karen Stretch, a senior associate specialising in derivatives at international law firm Dechert in London, to Global Custodian. “In both Europe and the US, there is now widespread discussion and calls by groups such as ISDA and other market participants to increase the threshold.”
As these reforms take hold, the pool of firms that will be expected to margin their bilateral OTCs is expected to dramatically widen. To preserve the integrity of the bilateral OTC market, those counterparties will need to post creditworthy securities – such as cash or highly rated government bonds – as margin.