ISDA Chief Executive Officer Scott O'Malia offers informal comments on important OTC derivatives issues in derivatiViews, reflecting ISDA's long-held commitment to making the market safer and more efficient.
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The coronavirus pandemic has forced firms to focus on critical priorities, like ensuring their continued operation and managing market risk in a period of severe volatility. This work is even more challenging as firms have implemented remote working and business continuity plans. For these reasons, we think it’s vital that global regulators agree a delay to the next phases of initial margin (IM) implementation until the situation and impact of coronavirus becomes clearer – a position we have set out in a letter to regulators signed by 21 trade associations.
We are grateful for the steps regulators have previously taken in recognition of the challenges that the IM rules will pose to smaller firms. Last July, for example, the Basel Committee on Banking Supervision and the International Organization of Securities Commissions extended the phase-in timeline to give the smallest entities an extra year to comply. According to ISDA analysis, that means 3,616 counterparty relationships will have to meet the requirements in September 2020, rather than the initial 9,059.
Even with this change, though, the number of firms in scope for phase five is far in excess of the number that has had to comply so far – and this would have posed a compliance challenge even in normal times. In the current situation, meeting the documentation and operational requirements would be all but impossible in an environment of staff shortages, remote working and extreme market volatility.
The phase-five implementation date of September 2020 may seem a long way away, but much of the preparation needs to be actioned now. For example, custodial agreements need to be put in place and documentation needs to be signed with counterparties – both of which are proving challenging due to resource issues and working from home, which is making it difficult to get documents physically signed.
With the focus on business continuity, there’s little or no spare capacity to deploy and test infrastructure, run average aggregate notional amount (AANA) calculations and implement margin calculation systems. AANA calculations are necessary for hundreds of counterparties in order to determine whether they will be subject to regulatory IM requirements. All in-scope counterparties also need to calculate and monitor IM amounts. That means the impact of keeping the current phase-in dates will extend far beyond the number of relationships that will actually need to exchange IM.
In light of the unprecedented circumstances, we urge global regulators to announce a delay to phase five sooner rather than later. Spaced phasing is important to ensure market participants have sufficient time to prepare for the next wave, so the phase-six implementation deadline would also have to be adjusted. Given the uncertainty, we recommend that revised deadlines for phase-five and phase-six implementation be set once the overall impact of COVID-19 is known. It’s important to point out that the largest, most systemically important firms would still be required to meet IM requirements, mitigating risk in the derivatives market.
We believe the IM requirements present an insurmountable hurdle for the industry given the rapid escalation of the coronavirus outbreak. Without a delay, it will almost certainly mean smaller entities will be shut out of the derivatives market, denying them the ability to manage their risk at precisely the time they need it most.
Developments, including information on market closures, regulatory relief and electronic execution, can be found here. Please email Covid19.MemberContact@isda.org if you have any questions.
Source: ISDA