Initial Margin: is it over?
11 October 2022
The quest for efficiency and optimisation does not stop with the final UMR implementation phase, according to BNP Paribas’ David Beatrix. For firms with a compliance process in place, careful monitoring is necessary to ensure everything is running properly. For firms that have not yet been impacted, they could be in the future
Image: David Beatrix
Initial margin rules for non-cleared derivative transactions have been progressively entering into force since 1 September 2016, released through a phased implementation with an increasing number of market participants subject to their requirements every year.
Phase 6 of the Uncleared Margin Rules was implemented in September 2022 and this has impacted a significant number of firms, including institutional investors. With this last wave now behind us, are we done with initial margin concerns?
Reminder on the initial margin rules
Exchanging initial margin (IM) on non-cleared derivative trades has become an established practice over the years. Now that we are past the final phase, all firms with an Aggregate Average Notional Amount (AANA) of non-centrally cleared derivatives (at consolidated group level) above €8 billion are subject to IM rules. All instruments — even physically settled forex forward and forex swap transactions that are exempted from IM requirements — count for the purpose of calculating the AANA.
Most financial counterparties trading non-cleared derivatives are “in-scope” and exemptions are very limited. As of today, the rules have been transposed in a number of jurisdictions (including the European Union, US, Japan, Australia, Hong Kong, Singapore). In many jurisdictions where the rules have been implemented, the treatment of third-country entities implies that most cross-border transactions entered into with entities incorporated in third-country jurisdictions are in-scope.
The range of non-cleared derivative instruments falling into scope of the regulation — that are subject to collection of IM — is generally consistent across the main jurisdictions in Europe, Asia Pacific and the US. Physically settled forex forwards and swaps are excluded across all jurisdictions.
However, some jurisdictions may have specific exemptions, either on a permanent basis (e.g. equity options and forwards are out of scope in the US) or on a temporary basis (e.g. equity options are exempted in the EU until January 2024).
IM rules have many specificities owing to the method for calculating IM amounts, the principle of bilateral exchange of margin (each party posts and receives at the same time), the possible relief with the €50 million threshold, and custodial segregation aspects. The compliance process is complex and can take from six to nine months on average. To manage these requirements, firms have different options to ensure compliance — whether implementing the rules by their own means, or appointing a service provider that can offer an end-to-end solution.
Staying alert
Although the final phase has passed, vigilance must endure.
For firms with a compliance process already in place, solid monitoring is necessary to ensure everything is running properly. Moreover, the quest for efficiency and optimisation does not stop. As IM exchanges take place and data is recorded, the market will be able to reflect and develop further efficiencies to ensure a smoother IM compliance process.
Additionally, there are firms that have not yet been impacted, but could be in the future. There are two main things for these firms to consider:
1. their Aggregate Average Notional Amount (AANA) and how to track its evolution. Approaching the €8 billion threshold should instantly trigger consideration of IM requirements and how to respond to them.
2. the relief mechanism linked to the €50 million threshold instituted by the Basel Committee on Banking Standards (BCBS), which we explore in more detail below.
Finally, the rules may change over time. As we observe reviews of other major regulations, we note that public consultations have recently taken place around the IM model validation framework for example. Some updates may arise in the short- to medium-term.
Buying more time
The relief mechanism has been introduced to take into consideration the differing levels of risk represented by different volumes of uncleared OTC derivatives trades. BCBS states:
“The requirements could impose some unnecessary operational costs on smaller entities that pose no significant systemic risk to the system and would not be expected to be bound by the initial margin requirements, in particular, in light of the provided threshold amount of €50 million.” (BCBS, Margin requirements for non-centrally cleared derivatives, April 2020)
As always, the devil is in the detail: this €50 million threshold is the maximum threshold a firm can set at consolidated group level with another trading relationship. For institutions having multiple entities, themselves in trading relationships with several branches of a bank, a significant part of the preparatory work is to map and allocate the appropriate threshold amount to each relationship, the function of the expected trading activity post-compliance date and the risk profile of the transactions. Finally, for the same relationship, it could also happen that these thresholds have been set in an asymmetric way between the pledger and pledgee directions.
If, for a given trading relationship, the uncleared OTC derivatives portfolio (“in-scope” — that is, having all of its trades executed after compliance date) has its IM amounts under the thresholds (€50 million or lower, depending on the allocation mechanism described previously), it is then exempt from posting IM until it reaches this threshold. Firms falling below the threshold are not expected to have specific documentation, custodial or operational processes related to IM in place. This, however, is only supposed to grant more time for firms to prepare for full IM compliance. Once this threshold is exceeded, firms are expected to have all necessary processes in place and operational.
Relying on the threshold requires precise monitoring. To this end, firms can rely on providers that offer such services. At BNP Paribas, we have developed a threshold monitoring service to accurately monitor that the IM threshold is not breached. This solution gives clients additional time to prepare for full IM compliance and allows them to keep trading even though their IM framework is not fully in place.
We offer threshold monitoring services in two ways:
• via our own IM management system, relying on clients’ portfolio data.
• through Acadia’s IM Threshold Monitoring module, relying on counterparties’ data.
This is offered alongside a full suite of IM services, including IM calculation, exposure management and pledge management via our triparty collateral service.
IM will also remain an area of focus on our side going forward. As a service provider, we continue to look for ways to further improve the quality of IM services for our clients.
Phase 6 of the Uncleared Margin Rules was implemented in September 2022 and this has impacted a significant number of firms, including institutional investors. With this last wave now behind us, are we done with initial margin concerns?
Reminder on the initial margin rules
Exchanging initial margin (IM) on non-cleared derivative trades has become an established practice over the years. Now that we are past the final phase, all firms with an Aggregate Average Notional Amount (AANA) of non-centrally cleared derivatives (at consolidated group level) above €8 billion are subject to IM rules. All instruments — even physically settled forex forward and forex swap transactions that are exempted from IM requirements — count for the purpose of calculating the AANA.
Most financial counterparties trading non-cleared derivatives are “in-scope” and exemptions are very limited. As of today, the rules have been transposed in a number of jurisdictions (including the European Union, US, Japan, Australia, Hong Kong, Singapore). In many jurisdictions where the rules have been implemented, the treatment of third-country entities implies that most cross-border transactions entered into with entities incorporated in third-country jurisdictions are in-scope.
The range of non-cleared derivative instruments falling into scope of the regulation — that are subject to collection of IM — is generally consistent across the main jurisdictions in Europe, Asia Pacific and the US. Physically settled forex forwards and swaps are excluded across all jurisdictions.
However, some jurisdictions may have specific exemptions, either on a permanent basis (e.g. equity options and forwards are out of scope in the US) or on a temporary basis (e.g. equity options are exempted in the EU until January 2024).
IM rules have many specificities owing to the method for calculating IM amounts, the principle of bilateral exchange of margin (each party posts and receives at the same time), the possible relief with the €50 million threshold, and custodial segregation aspects. The compliance process is complex and can take from six to nine months on average. To manage these requirements, firms have different options to ensure compliance — whether implementing the rules by their own means, or appointing a service provider that can offer an end-to-end solution.
Staying alert
Although the final phase has passed, vigilance must endure.
For firms with a compliance process already in place, solid monitoring is necessary to ensure everything is running properly. Moreover, the quest for efficiency and optimisation does not stop. As IM exchanges take place and data is recorded, the market will be able to reflect and develop further efficiencies to ensure a smoother IM compliance process.
Additionally, there are firms that have not yet been impacted, but could be in the future. There are two main things for these firms to consider:
1. their Aggregate Average Notional Amount (AANA) and how to track its evolution. Approaching the €8 billion threshold should instantly trigger consideration of IM requirements and how to respond to them.
2. the relief mechanism linked to the €50 million threshold instituted by the Basel Committee on Banking Standards (BCBS), which we explore in more detail below.
Finally, the rules may change over time. As we observe reviews of other major regulations, we note that public consultations have recently taken place around the IM model validation framework for example. Some updates may arise in the short- to medium-term.
Buying more time
The relief mechanism has been introduced to take into consideration the differing levels of risk represented by different volumes of uncleared OTC derivatives trades. BCBS states:
“The requirements could impose some unnecessary operational costs on smaller entities that pose no significant systemic risk to the system and would not be expected to be bound by the initial margin requirements, in particular, in light of the provided threshold amount of €50 million.” (BCBS, Margin requirements for non-centrally cleared derivatives, April 2020)
As always, the devil is in the detail: this €50 million threshold is the maximum threshold a firm can set at consolidated group level with another trading relationship. For institutions having multiple entities, themselves in trading relationships with several branches of a bank, a significant part of the preparatory work is to map and allocate the appropriate threshold amount to each relationship, the function of the expected trading activity post-compliance date and the risk profile of the transactions. Finally, for the same relationship, it could also happen that these thresholds have been set in an asymmetric way between the pledger and pledgee directions.
If, for a given trading relationship, the uncleared OTC derivatives portfolio (“in-scope” — that is, having all of its trades executed after compliance date) has its IM amounts under the thresholds (€50 million or lower, depending on the allocation mechanism described previously), it is then exempt from posting IM until it reaches this threshold. Firms falling below the threshold are not expected to have specific documentation, custodial or operational processes related to IM in place. This, however, is only supposed to grant more time for firms to prepare for full IM compliance. Once this threshold is exceeded, firms are expected to have all necessary processes in place and operational.
Relying on the threshold requires precise monitoring. To this end, firms can rely on providers that offer such services. At BNP Paribas, we have developed a threshold monitoring service to accurately monitor that the IM threshold is not breached. This solution gives clients additional time to prepare for full IM compliance and allows them to keep trading even though their IM framework is not fully in place.
We offer threshold monitoring services in two ways:
• via our own IM management system, relying on clients’ portfolio data.
• through Acadia’s IM Threshold Monitoring module, relying on counterparties’ data.
This is offered alongside a full suite of IM services, including IM calculation, exposure management and pledge management via our triparty collateral service.
IM will also remain an area of focus on our side going forward. As a service provider, we continue to look for ways to further improve the quality of IM services for our clients.
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