This past month in derivatives markets has felt a bit duck-on-a-pond-like. On the surface, it all looks calm, the duck is serenely gliding along, with nothing more than the occasional quack to break the silence. Under the water, though, its webbed feet are paddling furiously. So it is with the derivatives market, as the largest banks prepare for the start of non-cleared margining rules from September 1.
A couple of articles have recently picked up on the all-out effort to prepare for the rules – this one from Bloomberg, and this one from Risk. Both describe the huge documentation and system changes that have to be put in place, and the rush to get all this completed by the implementation date. They also pick up on the cross-border complexities that have emerged as a result of the fracturing of the global implementation timetable.
The articles cover a big, big issue. From next week, a first-phase group of large derivatives users will be required to post variation and initial margin on their non-cleared derivatives trades. These requirements were originally intended to be rolled out in a coordinated way across jurisdictions, but a decision by the Europe Union to defer its start date in June, followed by Australia, Hong Kong and Singapore earlier this week, means the rules will only be implemented on September 1 in the US, Canada and Japan.
Exchanging collateral on derivatives trades may not seem such a big deal. In fact, the rules will trigger the biggest transformation of derivatives markets in decades. That’s because they touch virtually every aspect of the non-cleared derivatives space – from pricing, funding and documentation, to IT, custody and collateral management. It’s required massive changes to infrastructure, technology and documentation, which have needed to be developed, implemented and tested. And it’s all had to be done very, very quickly. US prudential regulators were the first to issue final rules at the end of October 2015 – a little more than 10 months ago – while Japanese regulators published theirs at the end of March.
Given much of the detailed preparation and implementation couldn’t begin until these final rules were released, it’s meant a huge amount of complex work has had to be squeezed into a matter of months. That includes applying and testing the ISDA SIMM, a common model that will be used to calculate initial margin in the non-cleared space (here’s a short explanation), and adapting existing collateral documents. ISDA has published new credit support annexes (CSAs) for variation margin and for initial margin under various legal regimes, but each phase-one firm will likely need to execute between 100-200 CSAs with other phase-one entities.
This process has been made all the more difficult by the fact there’s now a cross-border element to this. The splintering of the timetable adds to the compliance complexity and could disrupt cross-border trading – margin requirements may or may not apply depending on the status and location of the counterparty, whether it has a guarantee from its parent, and whether it is consolidated with the parent entity for accounting purposes, among other things.
No wonder, then, that the Bloomberg and Risk articles suggest preparations are coming down to the wire. There’s going to be plenty of hard paddling over the coming days, as banks work hard to ensure they have everything in place on time.