Proposed recommendations will help reduce liquidity risk during market stress
FIA today filed a letter with international standard-setting bodies urging further progress on efforts to increase the resilience of global derivatives markets in times of stress.
The letter was submitted in response to a consultation on initial margin requirements in centrally cleared derivatives markets that was issued in January by the Basel Committee on Banking Supervision (BCBS), the Bank for International Settlements’ Committee on Payments and Market Infrastructures (CPMI) and the International Organization of Securities Commissions (IOSCO).
The standard-setting bodies called for comment on 10 policy proposals that aim to improve participants’ understanding of initial margin calculations and potential future margin requirements.
The FIA response expressed strong support for the proposed requirements for increased transparency into the process used by central counterparties to set IM requirements, saying it will give clearing members and their clients more ability to prepare for margin calls and thereby reduce liquidity risk in financial markets. As observed during recent periods of market stress, IM requirements can rise very fast when prices are volatile, and the resulting calls for additional margin can put stress on the ability of clearing members and market participants to fund these calls.
“We strongly support the proposed requirements on CCPs to provide additional disclosures and margin simulation tools,” said Jacqueline Mesa, global head of policy, FIA. “We believe that, if implemented and monitored consistently across jurisdictions, these proposals will increase transparency and enhance understanding of CCP margin models, their main components and their responsiveness to changing market conditions. This will help clearing members, their clients and more broadly, market participants, to be better prepared for sudden spikes in margin requirements.”
Addressing the challenges created by the volatility of IM requirements has been a top priority for FIA and its members for a number of years. As explained in a white paper issued by FIA in 2020, sudden increases in margin requirements can create a type of feedback loop called procyclicality. Margin calls drive demand for liquid assets at a time when those assets are scarce due to market stresses. This demand for liquid assets can spill over into other financial markets such as repo markets and can contribute to systemic risk.
This issue of margin procyclicality was demonstrated during abrupt market moves resulting from the Covid 19 pandemic in 2020, Russia’s invasion of Ukraine in 2022, and the “mini-budget” crisis in September 2022 – all of which led to sharp rises in IM requirements in centrally cleared derivatives markets.
FIA strongly believes that CCPs must retain the ability to adjust IM requirements in response to changing market conditions. Indeed, this is one of the strengths of the central clearing system. However, FIA also strongly believes that more transparency into margin models would help market participants better anticipate changes in IM requirements and prepare for margin calls, thereby reducing liquidity risk for both individual firms and the financial system as a whole.
Background:
FIA is the leading global trade organization for the futures, options, and centrally cleared derivatives markets. FIA’s mission is to support open, transparent, and competitive markets; protect and enhance the integrity of the financial system; and promote high standards of professional conduct. FIA’s membership includes clearing firms, exchanges, clearinghouses, trading firms and commodities specialists from more than 48 countries, as well as technology vendors, lawyers and other professionals serving the industry.
FIA has published several papers over the past few years exploring and recommending best practices for CCP risk management. They include:
- Revisiting Procyclicality: The Impact of the COVID Crisis on CCP Margin Requirements (October 2020)
- Central Clearing: Recommendations for CCP Risk Management (November 2018)
