The non-cleared derivatives market may face disruption as the final cohort falls under the BCBS-IOSCO’s initial margin framework, according to the International Swaps and Derivatives Association.
The cohort, which consists of firms with an average of $8 billion or more of notional exposure in non-cleared derivatives, will need to calculate two-way initial margin beginning in September 2020.
Scott O'Malia, ISDA
“This change will exponentially increase the number of entities subject to the rules,” said Scott O’Malia, CEO of ISDA during the association’s North American conference hosted in Midtown Manhattan. “Many of them will be small banks and buy-side firms that pose little or no systemic risk.”
Many of these firms may be familiar with variation margin, but the initial margin is an entirely different concept, he added.
Of the estimated 1,000 affected firms, each firm has an average of nine counterparty relationships that will need to be repapered as well as relationships with two tri-party custodians, noted Eric Litvak, chairman of ISDA and managing director, head of regulatory strategy at Société Générale Global Banking and Investor Solutions. "It is going to be a heavy lift for some."
Firms will need to adapt their existing systems and processes or build them from scratch to meet the initial-margin mandate, according to O'Malia.
"Initial margin calculation methodologies will also need to be implemented and tested," he said. "All of this comes at a time when everyone is doing the same thing. There are only so many lawyers available to negotiate these contracts. Unless we are instructed to implement these requirements now, there is a real risk that we will have a compliance problem come 2020."
And much of this work likely will be for naught as ISDA estimates that approximately 80% of the newly repapered counterparty relationships will fall below the $50 million margin threshold for exchanging initial margin.
To make matters worse, the derivatives market will have its hands full with benchmark-rate migration and the fallout from Brexit in 2020 as well.
"Even if we tackle them one by one, it will tax the resources of the market to the limit," said O'Malia. "Together they would be an enormous strain on firms' ability to comply with the rules."
ISDA has released a few tools to help firms prepare for their new regulatory requirements.
The industry body released version 1.1 of its Standard Initial Margin Model in August. ISDA has fully recalibrated its margin-calculation methodology and industry backtested it.
ISDA also published a beta version of its ISDA Create-IM online.
"This will enable firms to create, negotiate, and execute documents completely online and with multiple counterparties," said O'Malia. "It will make negotiations more efficient and shorten the process."
