Margin & clearing regulation: close but no cigar?

February 25 2019

Phil LloydHead of Market Structure & Regulatory Customer Engagement

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Margin & clearing regulation: close but no cigar?

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Behind the scenes the industry is scrambling on readiness for the final phases of Initial Margin and EMIR Clearing. There is however confusion on scope, requirements and whether the effort will be worth it. So where are we?

In November the FSB published their final report on Incentives to centrally clear over-the-counter (OTC) derivatives which concluded that financial regulatory reforms are achieving their intended goals of promoting central clearing.

But will more regulation reduce systemic risk further?

Smaller clients report difficulties obtaining access to central clearing, while the anticipated cost of implementing margin for non-cleared Phase 4 and 5 may be moot if the calculations result in no Initial Margin (IM) ever being exchanged.

The BIS understandably addressed the high-level risks to clearing in its 2018 BIS Quarterly report. It cited the concentrated nature of the clearing pool and the risk that banks and CCPs might interact in a way which serves to destabilize the marketplace via a negative feedback loop. This could be true even if portfolio-level risk is reduced between banks and their counterparties. Clearly the regulators do not want a systemic result that cancels out ground level benefits.

What is certain is that the upcoming phases for mandatory Initial Margin and Clearing will bring many new players into scope. Together with voluntary margining incentives, ISDA estimates that as many as 1,100 new market participants may enter the margining and clearing arenas by the time Phase V completes in 2020.

Is the market really aware of the ticking clock on the road to implementation? Have regulators taken enough notice to propose changes of scope in time for practical benefit?

Margin for non-cleared September 2019 & 2020

One of the challenges right now is estimating the number of new counterparties in scope and amount of IM to be exchanged.

  • In 2019 Financial Counterparties are brought into the regulation by having entered into more than EUR750bn notional (at a consolidated group level across all their dealers) in uncleared derivatives (including deliverable forwards and FX swaps) during the ‘lookback period’ Mar – May.
  • In 2020, Phase V threshold drops substantially to EUR8bn of notional with many more counterparties coming into scope.

The dramatic fall in threshold between 2019 and 2020 (EUR0.75trn to EUR8bn) will bring many participants into scope.

However there is another threshold that determines actual IM exchange despite being in scope of the regulation. This EUR50m threshold is the line at which IM is only exchanged for amounts over it and can be allocated across the trading entity. This in turn could lead to documentation, custodial accounts and operational capabilities sitting dormant.

It is expected that a significant number of the buy-side population will be caught over the two phases and change the nature of the non-cleared derivatives market. Across Phases IV and V, the estimated number of new agreements that will need to be put in place is 57,000 and 10+ custodians will be handling IM for the first time. ISDA, noting this has produced a white paper setting out reasons why the threshold needs to be higher thereby removing participants – whether this is successful is up for debate.

So what does this mean?

It will take time and resources to align documentation, operating models and prepare for compliance:

  • potentially Lengthy Documentation Negotiation
  • changes to Daily Collateral Processes and IM calculations
  • collateral Eligibility Modifications
  • sourcing & Costing of the collateral considerations.

EMIR Clearing June 2019

Under current EMIR regulation, counterparties in scope for clearing are divided into 4 categories with 2 and 3 being split by over / under the EUR8bn notional in OTC derivatives.

All categories are live with mandatory clearing save for Category 3. Since the EC is considering whether some FCs in Category 3 need to clear at all. The market was expecting a change to EMIR regulation, the ‘EMIR REFIT’, that would split Category 3 FCs into two more categories, either a FC having to clear or a Small Financial Counterparty (SFC) that won’t.

To determine whether a Financial Counterparty is a SFC, a group wide Annual AMEANA[1] assessment had been proposed, with a EUR3bn threshold suggested for rates products[2]. This SFC classification would be a direct EU response to Clearing House access and the associated costs as mentioned. This regulation would have made SFCs out of scope of the clearing obligation and by extension, MiFID2 Derivative Trading Obligations.

However, there are concerns that this change in regulation will not be passed in sufficient time before June 2019, when Category 3 FCs will become in scope for mandatory clearing. Currently the proposal is with the EC, but little clarity on when this regulation will now enter into force. It is possible that regulators may be prepared to exercise forbearance to permit SFCs not to clear but as yet there have been no statements.

Given the time it may take for a counterparty to set up clearing infrastructure (agreeing clearing brokers, MarkitWire, CDEAs etc), it is something affected market participants will need to take a view on.

With this evolving landscape the only certainty is that these regulations will change the way we operate therefore important we have an open dialogue.

All information correct at time of writing.

Market infrastructure & regulation
Initial Margin and EMIR Clearing


[1] Aggregate Month End Average Notional Amount
[2] Suggested Group Wide AMEANA Assessment for all products


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