Lynn Strongin Dodds look at BCBS, BIS and IOSCO’s efforts to bolster the resilience of the centrally cleared ecosystem by putting the lid on CCPs’ initial margin calculations
The Basel Committee on Banking Supervision (BCBS), the Bank for International Settlements’ Committee (BIS)on Payments and Market Infrastructures, and the International Organisation of Securities Commissions (IOSCO) are offering suggestions on how to bolster centrally cleared derivatives markets.
Industry participants will have three months or until mid-April – to mull over ten propositions in their consultative report – Transparency and responsiveness of initial margin (IM) in centrally cleared markets – review and policy proposals.
The objective, according to the regulators, is to “increase the resilience of the centrally cleared ecosystem by improving participants’ understanding of CCPs’ initial margin calculations and potential future margin requirements.”
In a nutshell, the key planks include enhanced information sharing, improved governance frameworks and greater transparency. This involves not only disclosure requirements for central counterparties (CCPs), but also margin simulation tools, metrics for monitoring margin responsiveness, margin model governance, and clearing member transparency.
Drilling down to the fine print, CCPs should share more information relating to their margining models, including the anti-procyclicality provisions that they have already implemented. They must also be required to disclose quantitative risk measures on a more frequent and timelier basis.
The paper also recommends CCPs install enhanced analytical and governance frameworks for margin models. Hand in hand is the reinforcement of the suite of margin simulation tools on offer to clearing members and the clients who have want sponsored access.
As for transparency, market participants should cast a light on their processes and procedures. For example, if CCPs use discretion to override model margin requirements, this should be done within a publicly disclosed analytical and governance framework where they offer clearing services.
Clearing members in turn should also be more visible to their clients and the CCPs. This translates into developing enriched analytical frameworks for assessing margin reactions when passing on margin calls to clients.
The regulators believe that these proposals could increase participants’ awareness of the total liquidity demands they may incur when clearing a portfolio at a CCP. They should also sharpen both clearing members and clients understanding of how a given model may respond to a broad set of market scenarios.
Moreover, the additional information would help participants better plan for stressed liquidity needs, which could help mitigate the potential negative effects of unpredictability and procyclicality.
The proposals were crafted in response to recent episodes of market turmoil, including the disruption caused by the onset of the pandemic in March 2020. Markets were taken by surprise when aggregate margin requirements spiked in both centrally and non-centrally cleared markets.
For example, a paper by the FIA found that IM requirements for certain benchmark contracts in the US, Europe and Japan soared by over 100% between the beginning and the end of the first quarter of 2020, with most of the increase happening during the month of March.
It found that the amount of initial margin held by the 10 major derivatives clearinghouses also jumped from $563.6 billion at the end of 2019 to $833.9 bn at the end of the first quarter of 2020, a $270.3 billion or 48% hike.
The pandemic, however, was not the only catalyst behind the BCBS, CPMI and IOSCO consultation. Markets were also rattled by the elevated volatility in commodities in early 2022 amidst Russia’s invasion of Ukraine. The price of gas more than doubled with oil prices surging $125 per barrel after the war started.
The future continues to look precarious due to extreme weather conditions, economic uncertainty and mounting geopolitical risks from the prolonged Ukraine and Russia war as well as Israel and the broader Middle East conflicts, according to a recent report from Euromonitor. Combined, it notes that these events have and will continue to threaten supply chains, production and exports.
This consultation report follows the publication of the BCBS-CPMI-IOSCO’s Review of margining practices in 2022. Last year, the three committees examined the impact of CCP margin models on market participants in the aftermath of Russia’s invasion of Ukraine.
The BIS said that there will be two more reports this year including a BCBS-IOSCO report Streamlining VM processes and IM responsiveness of margin models in non-centrally cleared markets. Meanwhile, CPMI-IOSCO will publish Streamlining variation margin in centrally cleared markets – examples of effective practices.
Another development to keep an eye out for in the first half of the year, according to the regulators, is the Financial Stability Board’s (FSB) high-level policy proposals on the readiness to meet margin and collateral calls by non-banks. This is not a new theme but has come to the fore thanks to tighter monetary policies, geopolitical risks as well as factors such as the UK’s liability driven investing crisis emanating from mini budget of Liz Truss’ short lived premiership.
These non-bank financial institutions have also grown in significance. Figures from the IMF Financial Stability Report 2023 report shows that they account for slightly less than half or 49.2% share of total global financial assets, surpassing banks with 37.6%. Central banks and public financial institutions account for the rest.
Although it is difficult to determine the final edict of all these consultations, there is no doubt that it will be another busy year for industry participants and regulators.
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Read more on clearing via our dedicated “Clearing” page.
