In order to maximise efficiency, minimise risk and reduce market fragmentation, national regulators must strive for harmonised margin requirements across the globe, ISDA says.
ISDA (the International Swaps and Derivatives Association) has released a new paper calling for increased consistency in the implementation of margin requirements, saying it will reduce the cost and complexity of cross-border trading and increase access to global liquidity pools.
Almost eight years after G20 leaders agreed to include margin requirements for non-centrally cleared derivatives among their post-crisis commitments, a significant number of jurisdictions have implemented IM (initial margin) and VM (variation margin) requirements for their largest market participants, in line with BCBS and IOSCO standards, ISDA says.
As a result of these reforms, firms now post more collateral to cover potential adverse changes in the value of derivatives transactions. Despite this progress, inconsistent implementation of certain requirements by some jurisdictions “stands in the way of efficiently addressing risk in the derivatives market”.
“In order to maximise efficiency, minimise risk and reduce market fragmentation, national regulators must strive for harmonised margin requirements across the globe.”
The paper highlights key areas where margin requirements have materially diverged among jurisdictions, creating “unnecessary complexity and costs for derivatives users” and contributing to market fragmentation.
The report says:
“While divergences between individual jurisdictions’ rule sets may appear minor or inconsequential, they can have significant impacts due to the global nature of the derivatives markets – particularly when building a compliance framework that can be used with counterparties across multiple jurisdictions.”
For example, some jurisdictions do not permit the full spectrum of collateral types for IM allowed by the agreed framework. As a result, counterparties trading across borders can only use collateral types permitted in both jurisdictions, which increases costs and inefficiencies in cross-border trading.
In addition, concentrating collateral in a limited number of assets may be problematic in times of financial stress, creating systemic risk concerns for firms operating globally.
Further, the differences in settlement times is not operationally practicable for both IM and VM, ISDA says. Margin calculation can only be made after a firm’s branches and offices are closed worldwide, and since global firms operate in different time zones, there is difficulty transacting in jurisdictions that require T+1 settlement, like the US.
“This is particularly problematic in the context of VM and for Asian counterparties transacting with entities located in the US,” ISDA says, adding that T+1 settlement also prevents the use of collateral types with longer settlement cycles.
ISDA highlights that once margin rules become effective for smaller market participants (September 2019 and September 2020), they may not have the operational means to transfer eligible collateral within a T+1 time frame, preventing them from accessing liquidity in T+1 jurisdictions, and placing dealers in those jurisdictions at a competitive disadvantage.
ISDA also argues that requiring the exchange and segregation of IM for inter-affiliate transactions diverts capital away from more efficient uses in the market. Currently only the US requires banks to exchange inter-affiliate IM, although the EU will impose IM requirements on inter-affiliate trades in 2020.
The report also highlights cross-jurisdictional differences in other key areas, such as in:
- model testing requirements, which could disadvantage smaller firms in some jurisdictions;
- IM product scope requirements, which raise the complexity and cost of performing IM calculations; and
- re-documentation requirements, which require clarification from national regulators in line with the latest BCBS/IOSCO statement to reduce the potential for competitive disadvantages.
ISDA argues that the effectiveness of the margin requirements depends on whether and to what extent global margin standards are consistently implemented by local jurisdictions.
“Consistency enables the industry to build effective tools for implementation, such as IM and VM documentation, the ISDA SIMM [Standard Initial Margin Model] and ISDA Create-IM [an online tool for negotiating and executing IM documents],” the paper says.
“Divergence in the implementation of IM and VM requirements across jurisdictions contributes to market fragmentation, increases the cost and complexity of cross-border trading and decreases access to global liquidity pools.”
The full paper is available here.