Non-cleared margin proposals still miss the point
The latest approach by global regulators to establish a framework for margin payments against non-cleared swaps will eliminate some unnecessary costs but still fails to address the core concerns of banks.
A joint consultation last week from the International Organization of Securities Commissions (IOSCO) and the Basel Committee on Banking Supervision (BCBS) proposed an exemption for initial margin payments on the first €50 million of bilateral swaps deals. Variation margin would need to be posted, based on the mark-to-market value of a trade on a daily basis.
As per their responsibilities under the Group of 20's 2009 mandate, US and European regulators are implementing rules that require OTC derivatives to be standardised, traded on exchange-like venues and centrally cleared. Swaps that cannot be standardised, and therefore remain bilaterally traded, would be subject to higher capital charges, to reflect the added risk they carry and incentivise the use of products that can be cleared.
While the margin for cleared swaps will be held at central counterparties, many industry participants are questioning the need for banks to exchange collateral with each other for privately negotiated deals.
"Margin for non-cleared products has been a huge stumbling block for the Basel working group dealing with this issue," Alex McDonald, CEO of the Wholesale Markets Brokers' Association (WMBA), told theTRADEnews.com. "The idea of banks paying each other initial margin to each other could be inefficient and potentially fraught with operational risk."
Rather than mandating the use of margin for non-cleared swaps, some brokers believe the best approach is to hold capital based on the risk-weighted exposures banks hold with one another.
"The most efficient way to manage the risk of non-cleared swaps is to use pillar one risk-weighted asset charges that already existed under Basel I and work perfectly well if calibrated correctly," added David Clark, chairman, WMBA. "This could be 2% for cleared products, as is the current direction of regulatory travel, but needs to be dynamic for bilateral swaps so it reflects the variety of risk profiles associated with these instruments."
While the BCBS-IOSCO principles still impose initial margin requirements, the €50 million threshold still appears sensible, according to Clark.
"By waiving margin for the first €50 million of exposures, you eliminate the need for small ticket corporate and bank hedging activity which generally net out and do not constitute a substantial risk," he said. "This appears to be a sensible trade off for the time being."
The initial margin requirement for non-cleared swaps was criticised by the International Swaps and Derivatives Association, which conducted analysis that showed it would cost an extra US$1.7 trillion – US$10.2 trillion in collateral, depending on whether internal models or standardised schedules are used.
The buy-side is expected not to be as concerned with margin for non-cleared swaps, given the phase-in period and thresholds that apply to when initial margin must be posted.
The IOSCO-BCBS paper states that in 2015, any "entity belonging to a group whose aggregate month-end average notional amount of non-centrally-cleared derivatives for the last three months of 2014 exceeds €3.0 trillion" will have to pay initial margin, which is not likely to cover any institutional investment firm. After 2019, the threshold drops to €8 billion on a permanent basis, which will cover many more asset managers.
In lieu of the punitive margin regime for non-cleared swaps, buy-side firms are already preparing for changes to the instruments they trade.
"The long phase-in period is welcome and will mean we will not have to post initial margin in the next few years," said Emmanuel Rolland, COO, derivatives management team at AXA Investment Managers, multi-asset client solutions department. "However, from that date onward, we will have to pay around four-to-five times more in initial margin for non-cleared swaps using the standardised initial margin, compared to cleared swaps, so we may look to more standardised instruments as an alternative given that currently the majority of our OTC derivatives trading would likely fall into the non-cleared bucket."
The IOSCO-BCBS consultation – described by the two bodies as 'near-final' – will be open for comment until 15 March.