[ D E R I V AT I V E S
R E V I E W
T
he requirement to post
collateral on non-centrally
cleared derivatives was a
logical final step in the global effort
to reduce systemic risk in the over-
the-counter derivatives market.
As a large chunk of contracts are
too complex and not sufficiently
standardised for central counter-
party clearing, mandatory margin
requirements should ensure there
is still sufficient collateral available
to offset losses in the event of a
counterparty default.
But like much of the post-crisis
reform programme, implemen-
tation has proved to be complex,
divisive and, at times, chaotic. Even
the largest dealers struggled to
meet a deadline last September for
the exchange of margin in the US,
Japan and Canada, despite having
been closely involved in the evo-
lution of the new framework. On 1
March, a much larger pool of sell-
side and buy-side participants was
due to begin exchanging variation
margin, marking the second phase
in the roll-out of the rules.
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V A R I AT I O N
M A R G I N S ]
Middle East and Africa at Northern
Trust.
Recognising the scale of the tran-
sition to this new regime, regula-
tors set a four-year phase-in for the
exchange of initial margin, which
is intended to cover any losses
between the point a counterparty
defaults and the close-out of the
trade. This phased implementation
meant only those dealers with the
largest volumes of non-cleared de-
rivatives on their books had to post
collateral in the first wave.
Major criticism
However, for variation margin,
which covers mark-to-market
changes in the value of a contract,
regulators controversially opted
for a ‘big bang’ approach, in which
almost all in-scope entities would
have to comply on 1 March. The
lack of a phased implementation
for variation margin has been
roundly criticised, given the op-
erational and legal complexity of
posting collateral. On 7 February, a
group of six industry bodies wrote
“When it comes to cross-border trades, the devil
is in the detail and firms are having to consider
the rules very carefully.”
DAVID BEATRIX, PRODUCT SPECIALIST FOR COLLATERAL AND
VALUATION SERVICES, BNP PARIBAS SECURITIES SERVICES
“There are many buy-side firms
that may never have had to ex-
change margin before, so they have
had to put the documentation and
infrastructure in place very quickly
or face being shut off from certain
dealers, which could threaten their
ability to achieve best execution,”
says John Southgate, head of
derivatives and collateral prod-
uct management for Europe, the
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TheTrade
Spring 2017
to regulators to request forbear-
ance after the deadline.
It is not so much that posting
collateral is an entirely new pro-
cess. Many firms already exchange
margin on a voluntary basis and
legal documentation in the form of
a credit support annex (CSA) has
historically set out the terms under
which collateral is to be trans-
ferred. But the new framework sets
stringent requirements on what
assets can be posted as collateral,
as well as how and when those
assets should be exchanged with a
counterparty.
Faced with a single implemen-
tation date and little time to
prepare, the new requirements put
extraordinary pressure on legal
resources in the lead-up to the
March deadline, as CSAs had to be
either drawn up for the first time
or re-drafted to reflect the new
legal requirements.
“The scale of this project has
been enormous, as the vast major-
ity of market participants became
subject to the rules at the same
time. Operationally, every single
in-scope party and the parties that
trade with them needed to under-
stand whether the rules applied
to them and their counterparties
and determine what changes were
needed to their bilaterally negotiat-
ed CSAs,” says Tara Kruse, head of
the non-cleared margin initiative at
the International Swaps and Deriv-
atives Association (ISDA).
ISDA has published a suite of
margin-compliant documentation
and other tools to help firms with
their compliance efforts, but mak-
ing the necessary changes to docu-
mentation still required significant
legal and compliance resource at
each firm. In the run-up to the
deadline, market participants
began expressing concerns that
many firms wouldn’t be ready in
time, leaving them unable to trade
without regulatory forbearance.
Documentation challenges
“Dealers had thousands of CSAs to
amend at the start of this year and
some level of prioritisation may
have been necessary prior to the
March deadline. That means that
small clients at the tail end that