Lynn Strongin Dodds looks at the latest set of recommendations on enhancing variation margin practices
Variation margin (VM) comes under the microscope in the Bank for International Settlement’s (BIS) Committee on Payments and Market Infrastructures (CPMI) and the International Organisation of Securities Commissions (IOSCO) new report– Streamlining Variation Margin in Centrally Cleared Markets: Examples of Effective Practices.
The aim is to encourage firms to tackle the operational and legal challenges that could potentially inhibit a seamless exchange of margin and collateral calls during a period of stress. To that end, the report sets out “eight effective practices” to illustrate how standards set out in the Principles for Financial Market Infrastructures (PFMI) and central counterparties (CCPs) resilience guidance can be met.
The examples cover several aspects of cleared VM practices, including scheduled and ad hoc intraday (ITD) VM calls, and the use of excess collateral held at CCPs to meet VM requirements. They also comprise pass-through of VM by CCPs, and CCP-clearing members (CM) and CM-client transparency regarding VM processes.
In addition, the report considers the case for greater flexibility in accepting non-cash collateral for VM within the set of permissible collateral types under the Working Group on Margining Requirements Framework, the Basel Committee – IOSCO framework that established minimum standards for margin requirements for non-centrally cleared derivatives and domestic regulation.
The regulators said that the effective practices outlined in the latest consultation were informed by three surveys which explored the challenges and solutions market participants were deploying. Canvassing 28 CCPs, seven CMs and three clients, the overall view was that central counterparties “may not be fully implementing the existing guidance related to VM practices and a result, further guidelines and best practice was required.”
The consultation, which closes on 14 April, also builds on the Review of Margining Practices discussion paper complied by IOSCO, the CPMI, and the Basel Committee on Banking Supervision in 2022. It highlighted several potential vulnerabilities ranging from ensuring firms were capable of dealing with higher-than-normal margin calls through to “the efficient collection and distribution” of variable margin in centrally cleared markets.
The number of reports and consultations may come as a surprise given the swathes of regulation issued in the wake of the financial crisis in 2008. They were designed to bolster the system, but the cracks appeared when inflation and interest rates suddenly spiked. A confluence of events over the past three years changed the macro economic picture and shook markets to the core. They ranged from the pandemic to an unexpected war in Ukraine and more recently conflict in the Middle East. Many market participants had never experienced, and they ran for cover, triggering fire sales in cash and derivative markets as they sold assets to raise the needed funds.
The UK was particularly hard hit with its own set of problems in 2022. The £45bn of unfunded tax cuts from the then prime minister, Liz Truss’ mini budget wreaked havoc and pension plans with liability driven strategies were in the firing line. This is because they used long-end gilts both to hedge themselves against falling yields and as their liquidity backstop. That meant when yields spiked, they were hit by margin calls that had to be met by selling gilts, sending yields higher and triggering more margin calls.
This led to a great deal of soul searching, consultations, reports, and guidance across the regulatory community. Earlier in the year, the standard-setters published Transparency and Responsiveness of Initial Margin in Centrally Cleared Markets which puts forward ten policy proposals designed to improve the resilience of central clearing infrastructure.
The report also recommended CCPs share more information relating to their margining models, including the anti-procyclicality provisions that they have in place. They should also be required to disclose quantitative risk measures on a more frequent and timelier basis.
Separately, the Financial Stability Board (FSB) is coordinating a wider project to develop cross-sectoral policy proposals on the ability of non-bank market participants to access the liquidity that they require to meet margin and collateral calls. A consultative report is expected to be released in the first half of 2024.
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Regulators Set Boundaries for Initial Margin
