November 28, 2012 / 4:21 PM / 5 years ago

ISDA pushes back on swaps margin rules

NEW YORK, Nov 28 (IFR) - As global regulators continue to hammer out new regulations that will make over-the-counter swaps more costly, the International Swaps and Derivatives Association is looking to salvage the bespoke, uncleared swaps market from what it considers to be dangerously high margin requirements.

The industry group on Tuesday released a quantitative impact study estimating that between US$1.7trn and US$10trn would be needed, depending on the use of specific models, to satisfy initial margin requirements for uncleared swaps laid out by an existing joint proposal from the Basel Committee on Banking Supervision and the International Organisation of Securities Commissions.

That squeeze on high-grade assets and cash would come on top of an approximate US$800bn tab for collateral on clearable swaps, estimated by the Bank of England and the Bank for International Settlements in separate reports. Standardised swaps are expected to be mandated into a cleared environment in the US in the first half of next year.

It will come as little surprise that the derivatives lobby is pushing back on rules that will at best make uncleared trades far more expensive and at worse kill off the market altogether. Bespoke derivatives, which make up around 20% of the total OTC derivatives notional outstanding according to ISDA, have long been an important source of profit for dealers.

Nonetheless, there is genuine concern across the industry that end-users will be unable to hedge specific risks via the uncleared market if the global supervisory groups recommend an overly onerous two-way initial margin requirement, as opposed to a one-way or zero IM requirement.

“The sensible approach would be to mandate universal variation margin without thresholds (with the usual exemptions) and have an observation period to review over time whether further specific measures relative to initial margin are necessary,” Eric Litvack, head of regulatory strategy at Societe Generale and ISDA Board Member, told IFR.

Variation margin is calculated on a daily basis and collected when a contract moves against a counterparty to cover its expected losses. Initial margin is posted at the outset of the trade and covers the possible multiplier effect of having one counterparty default on a trade.

ISDA argues that on top of being hefty, the proposed initial margin requirements are pro-cyclical as they will result in greatly increased demand for new collateral posting during stressed market conditions.

“Corporates, sovereigns, supranational organisations and investment firms use [uncleared swaps] in their financing and funding activities, and they are needed for the proper functioning of the housing markets,” said Robert Pickel, chief executive of ISDA in a release.

“ISDA believes that current margin proposals for non-cleared swaps could have a harmful impact on those vital markets and on systemic resiliency.”

Regulators believe raising margin requirements for derivatives is central to preventing another financial crisis and are likely to be reluctant to cede ground in the face of industry push back.

A key mission of the G20 regulatory reforms is to increase the transparency and robustness of the derivatives markets by encouraging the trading of swaps on exchanges. Levying initial margin requirements on uncleared swaps is viewed as a major tool in encouraging that migration.

But ISDA hopes to make a stand on the issue, arguing that tailored solutions cannot be cleared due to the lack of liquidity in bespoke contracts and that uncleared swaps must not be made so costly as to eliminate hedging capabilities.


The US$1.7-10trn estimate from ISDA comes from an analysis of submissions to the BCBS-IOSCO’s own working group, offered anonymously by market participants during a consultation period earlier this year. The BCBS-IOSCO has said they plan to release final guidelines by the end of 2012.

The US Commodity Futures Trading Commission introduced its own uncleared swaps margin rules ahead of the BCBS-IOSCO proposals, but quickly retracted and re-released proposals to put themselves on a timeline more closely aligned with the global supervisors after being vilified for jumping the gun.

The uncleared swaps margin debate is just one of many footnotes within a larger international regulatory narrative. Today, the CFTC is set to host a group of international regulators behind closed doors to discuss the CFTC’s reach in applying Dodd-Frank, a contentious topic that has roused criticism from international regulators towards the US.

And on Thursday, the CFTC is hosting a public meeting unexpectedly scheduled last week to discuss the mandatory clearing determination, at which they are expected to vote on rules to set the mandate in motion.

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