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About
Zhong Zhi Hu – European Banks Supervision
• Joined DNB in November 2015 with focus on Market Risk, Counterparty
Credit Risk, Liquidity Risk, Interest Rate Risk and Central Clearing
• Nerd at heart
• Fitness junkie and in love with travelling
Agenda
• This agenda item have been removed from this
“non-confidential/public” version
• This agenda item have been removed from this
“non-confidential/public” version
• Bilateral Margining and ISDA’s Standard Initial Margining Model
(SIMM)
• Round-table
Disclaimer
• Several slides that contain “confidential/non-public” content have
been removed
• Therefore this presentation can be shared. This document is for
educational purposes only
Bilateral Margining and ISDA’s Standard Initial Margining Model
(SIMM)
Zhong Zhi Hu – European Banks Supervision, 23-02-17
Financial crisis of 2007-2009
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US Government
Bailout
• Filed for bankruptcy in September 2008
• Many counterparties were protected by the collateral
posted by Lehman under ISDA Master Agreements
• Over 66,000 of Lehman’s OTC derivatives were
cleared at LCH.Clearnet
Margining of non-centrally cleared
derivatives (bilateral)History
2009: G20 seeks to reduce systemic risk in the non-centrally cleared OTC derivatives markets
• all standardized OTC derivatives should be cleared through central counterparties (CCPs) and traded on organized trading
platforms, where appropriate
• non-centrally cleared OTC derivatives should be subject to margin requirements and higher capital requirements
2013-2016: BCBS/IOSCO worked on a framework for margin requirements of non-centrally cleared derivatives
• Imposing two-way initial margin and unilateral exchange of variation margin
• Swaps and physically settled FX forwards are excluded from IM requirements but not from VM requirements
Regulation
• US: under Dodd-Frank Act by the US CFTC
• EU: under European Market Infrastructure Regulation (EMIR)
• Jan 2017: The EC has endorsed the final draft RTS by ESMA/EBA/EIOPA (ESA’s)
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Size of non-centrally cleared derivatives
2013Q4: USD 123-141 trn notional amount of non-cleared Interest
Rate Derivatives (IRD). This is ±175% of world GDP (2016)
• 21-25% of total IRD notional amount (USD 600 trn)
• 2015Q2: the notional amount of non-cleared IRD dropped to USD 86 trn
The non-cleared OTC derivatives market is unlikely to disappear
• Some OTC derivatives cannot be centrally cleared due to complexity and illiquidity
of some products. This poses difficulties for CCPs in developing valuation models
for computing margining requirements.
• Firms will always have tailored, bespoke risks they need to hedge
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EMIR definition of counterparties
Financial Counterparty
(FC)
- Credit institutions
- Insurers/reinsurers
- Investment firms
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Non-Financial Counterparty
(NFC+)
- Above clearing threshold
Non-Financial Counterparty
(NFC-)
- Below clearing threshold
- Excluded from margining
requirements
• FC and NFC+ are subject to margining requirements
• Central banks and sovereigns are not required to post margins
Phase-in period for IM requirements
Phase 1 - March 2017
Initial Margin requirements commence where aggregate month-end notional amount exceeds EUR 3 trillion
• only 12 EU entities meet this threshold
• Variation Margin requirements commence for all counterparties
• VM requirements will mainly impact smaller (financial) counterparties as most large counterparties
already post VM
Phase 2 - September 2017
Initial Margin requirements where aggregate month-end notional amount exceeds EUR 2.25 trillion
Phase 3 - September 2018
Initial Margin requirements where aggregate month-end notional amount exceeds EUR 1.5 trillion
Phase 4 - September 2019
Initial Margin requirements where aggregate month-end notional amount exceeds EUR 0.75 trillion
Phase 5 -September 2020
Initial Margin requirements where aggregate month-end notional amount exceeds EUR 8 billion
End of phase-in.
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Margining rules
• EU entities are obliged to collect and post margins to non-EU FC and NFC+
• Intragroup transactions are exempted from bilateral margining requirements if certain conditions
are met
Initial Margining
• No netting of IM between 2 parties, whereas ISDA master agreement allows for bilateral netting
• Concentration limit for IM collateral depending on nature (cash, bonds, equities)
• Strict rules on the segregation and rehypothecation of initial margin collateral
Variation Margining
• Parties are required to exchange VM daily subject to a minimum transfer amount of EUR 500k (EU)
or USD 500k (US)
• VM collateral can be rehypothecated and does not need to be segregated
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Margining computation
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Initial margining
• BCBS/IOSCO: IM may be calculated using a standardised margin schedule or an internal models (or a third party model)
• IM models should cover potential future exposure (PFE) at the 99% confidence level over a 10-day horizon
Variation margining
• Based on current exposure and is calculated by the mark-to-market value of derivatives
Standardised initial margin schedule (BCBS/IOSCO)
.
Fundamentals of ISDA SIMM
ISDA estimates the total IM for the entire market under standardised is USD 10.2 trn vs USD
1.7 trn under internal models
ISDA key requirements for a standard internal model
Similarity with FRTB
• Adopts essentially the same risk factors and models them in a similar way
• SIMM takes into account non-delta risks: vega and curvature sensitivities
• Main difference: IM is based on a 99% VaR while FRTB is based on a 97.5% Expected Shortfall
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• Easy to replicate and transparent
• Quick
• Extensible
• Low cost
• Governance
• Margin appropriateness
ISDA SIMM
Four product classes
• Interest rates and FX
• Equities
• Credit Qualifying (investment grade) and non-qualifying
• Commodities
IM amount
• IM per risk class IMrisk class = Deltarisk class + Vegarisk class + Curvaturerisk class
• Curvature and vega only need to be computed for products with optionality and volatility sensitivity respectively
• Netting only within product class: no cross-product class netting
• IM for product class
• r = risk class
• 𝜓 = correlation
• Total IM requirement for institution
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Six risk classes
• Interest rates
• FX
• Equities
• Credit Qualifying
• Credit non-qualifying
• Commodities
SIMM Methodology
ISDA SIMM methodology is based on a 2nd order Taylor polynomial
• Use of sensitivities (portfolio greeks) rather than “full reval” method
• Delta-gamma-vega approximation
• 𝛥 𝑉 ≈𝛿𝑉
𝛿𝑋∗ 𝛥 𝑋 + ½ ∗
𝛿2𝑉
𝛿𝑋2 ∗ 𝛥(𝑋)² +𝛿𝑉
𝛿 𝜎∗ 𝛥(𝜎)
• Δ(V) ≈ delta*Δ(X) + ½*gamma*Δ(X)² + vega*Δ(σ)
ISDA SIMM: no need to estimate Δ(X) and Δ(σ) that correspond to a 99% PFE
• These are hard to estimate for every traded OTC and form potential margining disputes
• ISDA provides risk weights (RW) and correlations which are calibrated to cover the PFE
at a 10-d horizon at ≥ 99%.
• Only need to compute the sensitivities
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SIMM computation
Netting set of two trades
• €20m 3-year payer swap with DV01 of -1500
• €5 m 10-year receiver swap with DV01 of 1200
𝑆𝐼𝑀𝑀𝐼𝑅 & 𝐹𝑋 = 𝐷𝑒𝑙𝑡𝑎𝐼𝑅 & 𝐹𝑋 + 𝐶𝑢𝑟𝑣𝑎𝑡𝑢𝑟𝑒𝐼𝑅 & 𝐹𝑋 + 𝑣𝑒𝑔𝑎𝐼𝑅 & 𝐹𝑋
𝑆𝐼𝑀𝑀𝐼𝑅 = 𝐷𝑒𝑙𝑡𝑎𝐼𝑅 (curvature and vega do not have to be calculated for IR swaps)
• 𝐷𝑒𝑙𝑡𝑎𝐼𝑅 = 𝐷𝑉013𝑌 ∗ 𝑅𝑊3𝑌2 + (𝐷𝑉0110𝑌∗ 𝑅𝑊10𝑌)
2 + 2𝜌3𝑌,10𝑌 𝐷𝑉013𝑌 ∗ 𝑅𝑊3𝑌 ∗ (𝐷𝑉0110𝑌∗ 𝑅𝑊10𝑌)
• 𝑅𝑊3𝑌, 𝑅𝑊10𝑌 and 𝜌3𝑌,10𝑌 can be found from ISDA SIMM tables
16
SIMM computation
𝐷𝑒𝑙𝑡𝑎𝐼𝑅 = 𝐷𝑉013𝑌 ∗ 𝑅𝑊3𝑌2 + (𝐷𝑉0110𝑌∗ 𝑅𝑊10𝑌)
2 + 2𝜌3𝑌,10𝑌 𝐷𝑉013𝑌 ∗ 𝑅𝑊3𝑌 (𝐷𝑉0110𝑌∗ 𝑅𝑊10𝑌)
• €20m 3-year payer swap with DV01 of -1500
• €5 m 10-year receiver swap with DV01 of 1200
ISDA SIMM risk weights 𝑅𝑊 for IR products of different currencies
• regular volatility currencies: USD, EUR, GBP, CHF, AUD, NZD, CAD, SEK, NOK, DKK, HKD, KRW, SGD, and TWD
• low-volatility currencies: JPY
• high-volatility currencies: all other currencies
17
SIMM computation
𝐷𝑒𝑙𝑡𝑎𝐼𝑅 = 𝐷𝑉013𝑌 ∗ 𝑅𝑊3𝑌2 + (𝐷𝑉0110𝑌∗ 𝑅𝑊10𝑌)
2 + 2𝜌3𝑌,10𝑌 𝐷𝑉013𝑌 ∗ 𝑅𝑊3𝑌 (𝐷𝑉0110𝑌∗ 𝑅𝑊10𝑌)
• €20m 3-year payer swap with DV01 of -1500
• €5 m 10-year receiver swap with DV01 of 1200
The margining rules allow for netting within product class
• 𝐷𝑒𝑙𝑡𝑎𝐼𝑅 = −1500 ∗ 47 2 + (1200 ∗ 45)2+2 ∗ 0.831 −1500 ∗ 47 (1200 ∗ 45)
• 𝑆𝐼𝑀𝑀𝐼𝑅 = 𝐷𝑒𝑙𝑡𝑎𝐼𝑅=39,484
Under no netting within product-class
• 𝐼𝑀3𝑌 = −1500 ∗ 47 2 = 70,500
• 𝐼𝑀10𝑌 = 1200 ∗ 45 2 = 54,000
• Individual margining amounts are higher due absence of netting benefits
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Concerns
• IM impacts market-wide liquidity as the IM collateral cannot be re-
used except in a fairly narrow set of circumstances
• It becomes harder to access the OTC markets, while most market
participants use OTC derivatives to hedge their risks
• Procyclicaclity
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Links
• BCBS/IOSCO http://www.bis.org/bcbs/publ/d317.pdf
• ISDA SIMM Methodology http://isda.link/simmmethodology
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