Derivsource

Lynn Strongin Dodds examines the BCBS, BIS CPMI and IOSCO’s final recommendations on fortifying the financial ecosystem’s defences.

The Basel Committee on Banking Supervision (BCBS), the Bank for International Settlements’ Committee on Payments and Market Infrastructures (BIS CPMI), and the International Organisation of Securities Commissions (IOSCO) have published three final reports recommending steps to improve transparency, streamline margin processes, and sharpen the predictability of margin requirements across cleared markets.

The reports, which were co-chaired by the Bank of England and the Commodity Futures Trading Commission, are part of a holistic work programme established by the three global standard-setting bodies to address the cracks in the financial ecosystem that were exposed during the pandemic five years ago.

As Covid 19 gripped the market, markets suffered from an unprecedented level of volatility and extremely high levels of trading activity across every asset class as market participants tried to keep pace with the unfolding pandemic.  The turmoil combined with the operational challenges from employees suddenly working from home put enormous pressure on the trading and clearing of infrastructureof the global derivatives markets.

Against this backdrop, initial margin (IM) requirements skyrocketed by about $300 bn in centrally cleared markets, while variation margin (VM) calls jumped by around $140 bn, with wide variances between asset classes, according to the groups’ initial report in 2022.

“Given the rapid increases in market volatility experienced in March 2020, there was a broad-based and rapid increase in margin calls across the financial system,” that report noted. In turn, these large, sometimes unpredictable margin calls created liquidity issues for some market players — and central banks were forced to intervene to guard against fire sales on certain assets.

The aim of the three reports is to help market participants’ and regulators understand IM requirements and responsiveness through increased transparency. They also assess the most effective ways to implement their proposals.  While the main target audience is financial market infrastructure firms, such as exchanges, clearing and settlement firms, the trio also wants to ensure that overall, market players have adequate liquidity to deal with larger-than-usual margin calls.  

Individually, each final version covers a different angle of the market. For example, the  BCBS, CPMI and IOSCO’s  Transparency and responsiveness of initial margin in centrally cleared markets – review and policy proposals sets out ten recommendations to boost the resilience of the centrally cleared market ecosystem in times of market stress. They cover aspects of central counterparty transparency, governance and review of IM models, as well as clearing member transparency for clients and CCPs.

Meanwhile, the CPMI and IOSCO’s Streamlining variation margin in centrally cleared markets – examples of effective practices report suggests eight practical methods to enhance market participants’ liquidity preparedness for above-average VM calls.  This is not only through greater transparency, but also more efficient collection and distribution of VM in centrally cleared markets. This can mean using scheduled and ad hoc intraday VM calls (called ITD VM calls), and other practices.

Last but not least is the BCBS and IOSCO’s streamlining variation margin processes and initial margin responsiveness of margin models in non-centrally cleared markets. It offers eight propositions to encourage the widespread implementation of good market practices such as rationalising VM processes and increasing the responsiveness of IM models.

The groups are not the only ones working to improve frameworks. Their work is complemented by the Financial Stability Board’s (FSB’s) ‘Final report on Liquidity Preparedness for Margin and Collateral Calls’, published at the end last year.

Its main focus was bolstering the defences of non-bank market participants including insurance companies, pension funds, hedge funds, other investment funds, and family offices. Its eight policy recommendations covered liquidity risk management and governance, stress testing and scenario design as well as collateral management practices.