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Managers Get Relief on Bilateral Margining

Published by Charles Gubert

Reform of the $595 trillion OTC derivatives market has been a regulatory priority ever since the financial crisis. While strong progress has been made towards transitioning vanilla OTC products into centralised clearing, a lot of contracts – either because their underlying properties do not align with CCPs’ exceptionally strict risk criterion or they are just too complicated – are still traded bilaterally between counterparties. Regulators concede these bilateral OTC trades are a systemic risk, but there are growing concerns – at least from the buy-side – about the regulatory treatment being levelled on some of these uncleared OTCs.

Six years ago, the Basel Committee on Banking Supervision (BCBS) and the International Organisation of Securities Commissions (IOSCO) created a set of global standards demarcating the margining requirements to be imposed on bilateral OTCs. Through tighter margining provisions, regulators hoped to avoid a scenario whereby OTC trades were at risk of being under-collateralised just as they had been during the 2008 crisis. Implementation of these wide-reaching BCBS/IOSCO guidelines has been ongoing for several years now, through legislation such as Dodd-Frank and the European Market infrastructure Regulation.

Right now, the bilateral margining rules only apply to financial institutions whose average aggregate notional amount (AANA) of uncleared OTC contracts exceeds USD/EUR 1.5 trillion. In September 2019, that threshold will drop to USD/EUR 750 billion. Most market observers say these current thresholds are perfectly acceptable. What riled the buy-side, however, were plans – scheduled to be enacted in 2020 – for the base sum to be lowered to USD/EUR 8 billion, a development which BNY Mellon estimated would ensnare more than 640 financial institutions. Predictably, industry associations have criticised the thresholds as being too low, as they capture a number of entities who are simply not systemically risky.

While several of these industry bodies advised regulators to raise the ceiling on the threshold for uncleared OTCs to circa USD/EUR 100 billion, it has so far fallen on deaf ears. However, IOSCO/BCBS did release a statement on July 23, 2019, stating it would delay the final implementation of the margining requirements for entities whose AANA of uncleared OTCs exceeds USD/EUR 8 billion by one year until September 2021. Nonetheless, IOSCO and BCBS pointed out that organisations with an AANA of uncleared OTCs greater than that of USD/EUR 50 billion will still be subject to the margining rules as planned in September 2020.  

The delay, however, was somewhat inevitable. Reports by a number of service providers had repeatedly indicated that many buy-side firms - who were due to post margin on their uncleared OTCs from September 2020 - were woefully underprepared and had yet to put in place the operational infrastructure necessary to facilitate effective collateral management.

While the delay should give buy-side firms a bit of manoeuvring room to enact operational changes, some industry groups are still hopeful the authorities could yet compromise on the USD/EUR 8 billion ceiling. Nonetheless, in-scope asset managers should use the one-year extension to better prepare their businesses for the incoming collateral requirements.