Proposals to impose variation and initial margin on OTC derivatives are “ill-conceived and unnecessary”, according to George Handjinicolaou, deputy CEO and head of Europe at the International Swaps and Derivatives Association (ISDA).
Handjinicolaou said the new collateral requirements implicit in the proposal – which ISDA estimates could range from US$1.7-10 trillion – were the “elephant in the room”, when speaking on a panel on regulatory developments at the Global Securities Financing Summit in Luxembourg yesterday.
In July 2012, a joint working group of the Basel Committee on Banking Supervision (BCBS) and International Organization of Securities Commissions (IOSCO) published a consultation which proposed that all financial firms and systemically-important non-financial entities engaged in non-centrally-cleared derivatives trading must exchange initial and variation margin “as appropriate to the risks posed by such transactions”.
Handjinicolaou said that the imposition of concepts from the centrally cleared derivatives markets was unnecessary as participants in the OTC markets already took counterparty risk factors into consideration as part of existing risk management processes. He also pointed out that estimates of the amount of new collateral required by the proposals would rise by “multiples” in times of market stress. ISDA is also concerned that the proposed use of thresholds to decrease initial margin requirements could “amplify the pro-cyclicality of the initial margin requirement during market stresses and add to systemic risk concerns”.
“In their attempts to correct the financial system, regulators may be overshooting and creating a collateral crunch,” warned Handjinicolaou.
Also speaking at the event, Benoit Coure, member of the executive board of the European Central Bank, said that the need for efficient flow of collateral required European market participants and infrastructures to work closely to support tri-party settlement interoperability.
ECB urges interoperability efforts
Arguing that interoperability between the collateral management systems of Europe’s two international central securities depositories (ICSDs) would help market participants to avoid fragmentation of their liquidity pools, Coure noted that key parties involved in tri-party settlement interoperability “have started to show signs of retreating” in recent months. Declining to “name and shame” the parties in question, Coure urged further efforts toward greater cooperation.
“While the ECB understands the complexity of establishing a tri-party interoperability model and the substantial efforts and in particular the investment costs required to make it work, it would like to strongly urge all parties to continue to work together. Interoperability will bring important benefits – by allowing a more efficient use of collateral by bringing together separate pools of liquidity,” he said.
A link between European ICSDs Euroclear and Clearstream to facilitate the flow of collateral held by banks in either ICSD recently stalled, with both technical and financing issues being cited.