The VM Protocol tries to make life easier but the documentation challenges are still difficult
The clock is ticking and March 2017 is only six months away until the new margin variation rules have to be implemented by all market participants. The largest players are already at the starting gate but the International Swaps and Derivatives Association (ISDA) has introduced a new protocol that aims to lighten the documentation burden.
The task will vary depending on the activity but the bigger firms are faced with the daunting challenge of having to pen hundreds, if not thousands of new collateral agreements. The challenge was underscored in ISDA CEO Scott O’Malia prepared statement which said that “the new margin rules for non-cleared derivatives represent a huge change for the market, and will require firms to make important changes to their derivatives documentation to ensure they comply with the requirements in each jurisdiction.”
The Protocol enables counterparties to put contractual documentation in place with multiple counterparties to meet the new requirements or make changes to existing collateral agreements to bring them into compliance.
However, it is more complicated and onerous process than traditional ISDA protocols which were limited to relatively minor, straightforward or representation fixes. The new VM protocol will require major amendments to existing commercial and operational terms of contractual documents and even create brand new ones.
One of the biggest changes is that parties will have to submit an adherence letter to ISDA and also to exchange questionnaires with a counterparty to strike substantive protocol terms with that counterparty. According to law firm, Simmons and Simmons, the questionnaires are designed to provide the same flexibility for parties that would be available in a traditional bilateral negotiation of credit support annex terms. The swap dealers and their counterparties can identify applicable regulatory regimes and make changes to existing collateral agreements to bring their variation margin arrangements into compliance.
Market participants though are not obliged to use the VM Protocol. It represents just one method of amending or creating CSAs in order to meet the new margin requirements. Simmons and Simmons note that for certain market participants, the VM Protocol may offer an administratively efficient method of making the necessary amendments. However, others may find the complexities involved with potentially numerous questionnaires and the matching process a daunting prospect and would prefer to negotiate CSA terms on a bilateral basis.
Whichever method is used, all in-scope market participants as well as those not impacted by the initial wave of IM and VM requirements are encouraged to start to build a framework for dealing with the VM requirements and the required documentary changes.
Although the European Union has delayed the launch of the European Market Infrastructure Regulation margin requirements, the VM requirements are still currently expected to apply from March 2017 for all in-scope market participants. The largest players start exchanging both initial and variation margin on their non- cleared derivatives on 1 September while the subsequent compliance deadlines will be phased in over the next four years in a schedule developed by the Basel Committee on Banking Supervision and the International Organisation of Securities Commissions.
See related commentary: The ISDA 2016 Variation Margin Protocol – A Step Too Far?
