Initial Margin for Non-Centrally Cleared Derivatives ...· 4 able to trade non-centrally cleared derivatives,

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Initial Margin for Non-Centrally Cleared Derivatives:

Issues for 2019 and 2020

July 2018

This paper is intended for discussion purposes only. Drafts of this document are subject to change as views and issues

develop further.

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Contents I. Introduction ........................................................................................................................................................3

II. Executive Summary ............................................................................................................................................4

III. Background .........................................................................................................................................................7

IV. Challenges for Newly In-Scope Counterparties ..................................................................................................9

A. Entity Assessment and Disclosure ............................................................................................................... 10

B. Credit Support Annexes ............................................................................................................................... 11

C. Custodial Arrangements .............................................................................................................................. 13

1. Account Control Agreements .................................................................................................................. 13

2. Eligible Collateral Schedules .................................................................................................................... 15

3. Connectivity ............................................................................................................................................. 15

D. Determination of In-Scope Trades, Netting Sets ......................................................................................... 17

1. Lack of Global Harmonization and Higher of IM .................................................................................. 18

2. Legacy and In-Scope Portfolio Management .......................................................................................... 18

3. Regulatory vs. Non-Regulatory Initial Margin ......................................................................................... 19

E. Initial Margin Model Implementation ......................................................................................................... 19

1. Calculation Methodologies ...................................................................................................................... 19

2. Evidence of Proper Implementation ....................................................................................................... 22

3. Margin Monitoring .................................................................................................................................. 23

4. Model Approval ....................................................................................................................................... 24

F. Margin Reconciliation .................................................................................................................................. 25

G. Liquidity and Funding .................................................................................................................................. 27

V. Work Needs to Be Done .................................................................................................................................. 28

A. Newly In-Scope Entities Readiness ............................................................................................................. 29

B. Custodian Readiness .................................................................................................................................... 29

C. Middleware Readiness ................................................................................................................................ 29

D. Dealer Role .................................................................................................................................................. 30

E. Industry and Trade Associations ................................................................................................................. 31

F. Regulators .................................................................................................................................................... 32

VI. Conclusion ....................................................................................................................................................... 33

VII. Appendices ...................................................................................................................................................... 35

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I. Introduction

In response to the global financial crisis of 2008-2009, the G20 agreed to a financial regulatory reform

agenda covering the over-the-counter derivatives markets and market participants.1 Among these agreed

reforms were recommendations for the implementation of margin requirements for non-centrally cleared

derivatives. The Basel Committee on Bank Supervision and International Organization of Securities

Commissions (BCBS-IOSCO) subsequently developed and finalized their Final Framework on Margin

Requirements for Non-Centrally Cleared Derivatives (BCBS-IOSCO Final Framework),2 which sought to

establish international standards for such requirements, to be phased in over time.3

Regulators around the world have since implemented margin requirements for non-centrally cleared

derivatives generally in accordance with the Final Framework, but with some critical differences in certain

instances. These rules are commonly referred to as the Uncleared Margin Rules (UMR), and margin

collected and posted under UMR is referred to as regulatory margin. As agreed in the revised

implementation timeline to the Final Framework, UMR began to be phased-in on September 1, 2016 for the

largest market participants. Broader implementation of variation margin (VM) requirements occurred in

March 2017, while initial margin (IM) requirements continue to phase-in annually through 2020.4

The final phases of UMR will occur on September 1 of 2019 and 2020, when a large number of additional

counterparties will be brought into scope for IM requirements. The significant number of counterparties

coming into scope in the final phases will create an untenable rush of demand on market resources across

participants and service providers in a relatively short time period. This in turn will result in significant

operational and technology builds that must be undertaken to meet the swell of demand. Further

complicating matters is the number of contractual agreements, which are often heavily negotiated, that

must be put into place. If not done in a timely manner, newly in-scope counterparties (NISCs) may not be

1 G20 Pittsburgh Summit (Sept. 24-25, 2009). 2 See BCBS-IOSCO Final Framework on Margin Requirements for Non-Centrally Cleared Derivatives (Sept. 2013), available at: http://www.iosco.org/library/pubdocs/pdf/IOSCOPD423.pdf. 3 This included the implementation of requirements relating to (i) initial margin, which is intended to cover exposures that may arise in the period from the default of one party to the time when the portfolio of non-centrally cleared OTC derivative transactions are closed out or replaced, and (ii) variation margin, which is intended to cover the daily change in market exposure on the portfolio in question.

4 In March 2015, BCBS-IOSCO revised the implementation timeline for the Final Framework. See: https://www.bis.org/bcbs/publ/d317.htm.

http://www.iosco.org/library/pubdocs/pdf/IOSCOPD423.pdfhttps://www.bis.org/bcbs/publ/d317.htm

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able to trade non-centrally cleared derivatives, limiting their options for both taking on and hedging risks,

and also potentially impacting liquidity in the derivatives markets.

The effort that will be undertaken in anticipation of September 2019 and 2020 far surpasses that associated

with the previous phases of implementation. Larger institutions brought into scope for IM in earlier phases

were able to absorb the implementation timeline, build and costs of compliance in a manner that NISCs for

the final phases may not. The fundamental challenges for market participants during the final phases of IM

implementation are distinct from and more intense than those experienced in previous phases, and thus

likely to result in broader systemic impact.

In this paper, the International Swaps and Derivatives Association (ISDA) and the Securities Industry and

Financial Markets Association (SIFMA) (together, the Associations)5 seek to highlight the significant

challenges market participants will encounter during the final phases of IM implementation and identify the

key tasks and resulting hurdles that must be overcome to ensure an orderly implementation that avoids

disruption to the functioning of the derivatives market.

II. Executive Summary

The OTC derivatives market faces substantial challenges as new counterparties come i

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