Fear of collateral crunch impacted the latest proposal of global margining standards for uncleared trades

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Back in October last year we published our whitepaper and market commentary around the challenges of collateral management in the light of current regulations like EMIR, CRD IV/CRR and the Dodd-Frank Act. The fear of a collateral crunch is still around as estimates for the additionally required collateral are widely spread, based on the publishing institution and their assumptions – but all alarmingly high.

Most of these estimates so far just included the increased collateral requirements out of the clearing obligation. But EMIR and DFA will bring an additional obligation aggravating the collateral crunch – the margining requirements for non-centrally cleared deals. It is one of the areas of EMIR which has not been addressed through ESMAs technical standards so far, as there was a decision to wait for international standards to be established by a joint effort of BCBS and IOSCO. Those international standards should have been finished by end-2012, but that deadline was missed.

On Friday, February 15th BCBS and ISOCO released their second consultative document which they consider to be in a very late stage of final completion. It contains quite significant changes compared to the first version – mainly aimed at reducing the overall collateral impact in a reaction to the results of their quantitative impact study which projected a global initial margin increase of EUR 1700bn.

We have summarized the most important changes in the bullets below:

  • REPO and S/L (described as sharing only some attributes with derivatives) are explicitly exempt from margining requirements
  • For FX Swaps and FX Forwards BCBS & IOSCO are seeking comments on exempting these instruments from initial margin, while variation margin would be governed by either national regulation or BCBS guidance. The question of treatment by different maturity is being re-raised
  • Multilateral Development Banks eligible for a zero-risk weight under the Basel capital framework are exempt from margining requirements (for example: EBRD, EIF, ICF…)
  • Threshold of € 50m is applied on group level; derivative exposure below does not require collateralization. This threshold can be applied to any affiliated company within the group – however the maximum amount deductible per group remains at € 50m
  • Minimum transfer amount of margin € 100.000
  • Re-hypothecation of assets question re-raised with strict conditions: (i) only non-proprietary positions, (ii) pledgee has to treat re-hypothecated collateral as customer asset, (iii) insolvency regime must allow customer first priority claim over collateral
  • Phase-in of initial margin requirements over a 7 year period for covered entities (financial entities and systemically important non-financial entities). Note that the requirement to exchange variation margin is not phased-in and will apply from January 1st 2015:
    2015 only covered entities with > € 3tn derivatives notional subject to requirements
    2016 > € 2,25tn
    2017 > € 1,5tn
    2018 > € 0,75tn
    2019 everyone above € 8bn

The paper also includes the results of the QIS (Quantitative Impact Study) conducted during the last consultation period with data from 39 institutions including 33 banks, 19 of which are large international active dealers and represent about 75% of global non-centrally cleared derivative activity. The QIS expects a 46% reduction in bilateral notional amount – as a result of central clearing; Interest Rate and Equity Derivatives to exhibit the steepest drops in notional, both expected to drop more than half. The initial margin requirements of respondent firms would have increased by EUR 558bn – an extrapolated EUR 1700bn globally. By applying the proposed changes that number is expected to go down to EUR 700bn.

While the changes clearly ease collateral requirements compared to the first draft it does not ease the overall future challenges of collateral management. We are still confident that financial institutions that recognize the situation as a chance and evolve collateral management into a front-office function will gain a competitive advantage.
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