BCBS-IOSCO: don’t get caught out
24 February 2015
Multiple but different implementations of margin requirements for non-centrally cleared derivatives transactions are challenging buy- and sell-side firms, according to Lombard Risk
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You might be thinking that margining for derivatives trades in three jurisdictions is like playing bridge on three tables, simultaneously. And it is harder than that because each table has different rules. If new margin rules come into play as planned, derivatives users will need to learn how to play in Europe, Japan and the US from December 2015. Getting margin calls wrong is a very expensive business for buy- and sell-side firms and managing this multi-jurisdictional process will demand a highly disciplined approach.
The rules in each market share a lineage. The need for margin requirements for non-centrally cleared derivatives transactions was mandated in 2011 by the G20 as a common starting point. Then in September 2013, the Basel Committee on Banking Supervision (BCBS) and the International Organisation of Securities Commissions (IOSCO) firmed things up with their principles for margin requirements. These set out a framework to reduce systemic risk and promote central clearing by establishing:
The rules that are being proposed in Europe, Japan and the US use this framework as guidance. The BCBS-IOSCO’s terminology—‘appropriate’, ‘important’ and ‘confidence’—has given regulators that transpose the framework into local rules considerable flexibility.
Mind the gap
Differences between jurisdictions can be significant. For example, in Europe regulators are talking about imposing an additional 8 percent haircut if a firm does not pay the collateral in the currency of the trade, while US regulators are proposing that firms are able to pay in the currency of the trade or dollars, which would mitigate such costs.
Europe allows a slightly broader set of collateral than the BCBS-IOSCO or US rules. That will provide some relief in terms of liquidity, although with significantly greater haircuts required where that is exercised. The period of data required for calibration of margin requirements differs between jurisdictions. In Europe, the incumbent model of title transfer to move collateral has been disrupted by the requirement for posting of bankruptcy-remote initial margin.
Jurisdictions, such as Singapore are keen to meet international standards to support their own growing derivatives markets but are equally free to deliver their own nuances to the BCBS-IOSCO framework.
Investment managers and derivatives dealers must prepare for the existing proposed rules and the potential variations they can expect to appear in localities around the world. Furthermore, challenges to the proposed rules are ongoing—for example, the December 2015 deadline in the US and Europe may be pushed back by up to two years—which increases the potential for adjustment of the rules.
Internal struggle
Firms subject to these regulations need to make margin calculations, source the right collateral and apply appropriate haircuts to assets. Although each of the jurisdictions in which they operate will have separate demands, calibration of margin requirements has to take place at a group level, which requires a centralised consolidated view of exposure and risk.
From an operational standpoint, a platform is needed that can aggregate this data, then apply the appropriate model and calculations as needed in order to operate across the legal entities that form the group and legal borders. It must account for each instrument type and for the unique approach each regulator takes to the relevant margin requirements. To optimise the use of collateral, the firm should be able to consider the pros and cons of existing inventory and assess the cost of acquiring collateral.
That assessment should take in the use of a listed derivative as an alternative to an uncleared swap. For example, under existing capital adequacy rules: highly liquid listed derivatives have a margin based on a two-day value-at-risk (VAR); for an over-the-counter (OTC) product, a five-day VAR charge is applied; and for non-cleared swaps, that is extended to a 10-day VAR charge. Deciding which instrument is optimal given the potential costs can deliver enormous savings.
Moving with the times
Not only should a platform be powerful, it should be flexible. With reviews of existing rules ongoing by the Commodity Futures and Trading Commission (CFTC), the potential for change of the current parameters is considerable. That means that a hardwired, purpose-built system that deals with a current set of market rules could quickly find itself overstretched.
An institution with five legal entities needs to understand what its exposure and thresholds are across all of its agreements, stretching across all of those entities. Many counterparties are not in a position to access data at that consolidated level.
Developing a solution in-house is challenging because the resources needed to support the platform may need to be deployed as a rolling cost base to mirror the potential changes the rules may experience. No two firms are alike—a patchwork of systems will already exist to gather this data and run calculations in many firms, but its extent and rigor will vary. A solution is needed that can be integrated with that patchwork, or to replace manual processes where they exist, and predict margin pressures, analyse inventory and deliver real-time-margin calculations within the relevant regulatory framework.
Lombard Risk has developed its COLLINE system to provide this capability for buy- and sell-side participants. It uses a modular structure that can fill the breach wherever there is a gap in capability. Deployed either in-house or over the cloud, COLLINE can fit into the technology infrastructure of any market, with Lombard Risks’s capacity to monitor rule changes applied to every users’ processes. That keeps a firm compliant, while meeting its precise needs and at a cost that reflects use.
Most importantly, the platform can adapt to any new jurisdiction that a firm moves into and cope with any rule change that existing regulators impose. Deployed now, COLLINE gives the reassurance of efficient compliance whatever lies ahead
The rules in each market share a lineage. The need for margin requirements for non-centrally cleared derivatives transactions was mandated in 2011 by the G20 as a common starting point. Then in September 2013, the Basel Committee on Banking Supervision (BCBS) and the International Organisation of Securities Commissions (IOSCO) firmed things up with their principles for margin requirements. These set out a framework to reduce systemic risk and promote central clearing by establishing:
- That margining practices must be put in place for non-cleared transactions;
- Which types of firm must exchange initial or variation margin;
- What the acceptable characteristics of assets to be posted as margin are and the acceptable way for transactions to occur; and
- The need for a consistency of rules between jurisdictions and appropriate timeliness.
The rules that are being proposed in Europe, Japan and the US use this framework as guidance. The BCBS-IOSCO’s terminology—‘appropriate’, ‘important’ and ‘confidence’—has given regulators that transpose the framework into local rules considerable flexibility.
Mind the gap
Differences between jurisdictions can be significant. For example, in Europe regulators are talking about imposing an additional 8 percent haircut if a firm does not pay the collateral in the currency of the trade, while US regulators are proposing that firms are able to pay in the currency of the trade or dollars, which would mitigate such costs.
Europe allows a slightly broader set of collateral than the BCBS-IOSCO or US rules. That will provide some relief in terms of liquidity, although with significantly greater haircuts required where that is exercised. The period of data required for calibration of margin requirements differs between jurisdictions. In Europe, the incumbent model of title transfer to move collateral has been disrupted by the requirement for posting of bankruptcy-remote initial margin.
Jurisdictions, such as Singapore are keen to meet international standards to support their own growing derivatives markets but are equally free to deliver their own nuances to the BCBS-IOSCO framework.
Investment managers and derivatives dealers must prepare for the existing proposed rules and the potential variations they can expect to appear in localities around the world. Furthermore, challenges to the proposed rules are ongoing—for example, the December 2015 deadline in the US and Europe may be pushed back by up to two years—which increases the potential for adjustment of the rules.
Internal struggle
Firms subject to these regulations need to make margin calculations, source the right collateral and apply appropriate haircuts to assets. Although each of the jurisdictions in which they operate will have separate demands, calibration of margin requirements has to take place at a group level, which requires a centralised consolidated view of exposure and risk.
From an operational standpoint, a platform is needed that can aggregate this data, then apply the appropriate model and calculations as needed in order to operate across the legal entities that form the group and legal borders. It must account for each instrument type and for the unique approach each regulator takes to the relevant margin requirements. To optimise the use of collateral, the firm should be able to consider the pros and cons of existing inventory and assess the cost of acquiring collateral.
That assessment should take in the use of a listed derivative as an alternative to an uncleared swap. For example, under existing capital adequacy rules: highly liquid listed derivatives have a margin based on a two-day value-at-risk (VAR); for an over-the-counter (OTC) product, a five-day VAR charge is applied; and for non-cleared swaps, that is extended to a 10-day VAR charge. Deciding which instrument is optimal given the potential costs can deliver enormous savings.
Moving with the times
Not only should a platform be powerful, it should be flexible. With reviews of existing rules ongoing by the Commodity Futures and Trading Commission (CFTC), the potential for change of the current parameters is considerable. That means that a hardwired, purpose-built system that deals with a current set of market rules could quickly find itself overstretched.
An institution with five legal entities needs to understand what its exposure and thresholds are across all of its agreements, stretching across all of those entities. Many counterparties are not in a position to access data at that consolidated level.
Developing a solution in-house is challenging because the resources needed to support the platform may need to be deployed as a rolling cost base to mirror the potential changes the rules may experience. No two firms are alike—a patchwork of systems will already exist to gather this data and run calculations in many firms, but its extent and rigor will vary. A solution is needed that can be integrated with that patchwork, or to replace manual processes where they exist, and predict margin pressures, analyse inventory and deliver real-time-margin calculations within the relevant regulatory framework.
Lombard Risk has developed its COLLINE system to provide this capability for buy- and sell-side participants. It uses a modular structure that can fill the breach wherever there is a gap in capability. Deployed either in-house or over the cloud, COLLINE can fit into the technology infrastructure of any market, with Lombard Risks’s capacity to monitor rule changes applied to every users’ processes. That keeps a firm compliant, while meeting its precise needs and at a cost that reflects use.
Most importantly, the platform can adapt to any new jurisdiction that a firm moves into and cope with any rule change that existing regulators impose. Deployed now, COLLINE gives the reassurance of efficient compliance whatever lies ahead
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