|ISDA Warns Of $10 Trillion Liquidity Drain From New Margin Rules|
|November 27, 2012 18:07 (CET)|
The International Swaps and Derivatives Association (ISDA), the trade body for derivatives market participants, has warned that new proposals from global regulators to introduce mandatory initial margin payments for non-cleared derivatives contracts could drain over $10 trillion in liquidity from the global financial system.
ISDA’s warning, issued today in a press release, comes in response to a July consultation paper from two global regulators, the Basel Committee on Banking Supervision (BCBS) and the International Organisation of Securities Commissions (IOSCO), in which the regulators called for higher capital requirements for all derivatives contracts that are not centrally cleared.
Central clearing allows for the multilateral netting of exposures between financial market counterparties and is a key objective of derivatives market regulators since the 2008 financial crisis.
Market counterparties which engage in non-centrally cleared derivatives transactions must start to exchange initial and variation margin payments that reflect the risks posed by such transactions, say BCBS and IOSCO.
At present only around 10% of credit derivatives contracts and around 50% of interest rate swaps are centrally cleared, the Bank of England estimated in its summer Financial Stability Report.
ISDA estimates that 80 percent of the derivatives contracts currently traded “over-the-counter” (OTC—on a bilateral basis) can be cleared in principle, but that $127 trillion of the global derivatives market is “unclearable”.
Regulators have made it clear that margin requirements in the OTC derivatives market must be tightened in order to push trading onto central platforms, with the objective of reducing systemic risk.
“If bilateral margin requirements are laxer than margin requirements for central clearing, there may be incentives to bypass central clearing requirements,” the Bank of England noted in the summer.
“Bilateral transactions also make for a complex web of interconnections between institutions. To overcome these risks, regulations are being developed to set margin requirements for non-cleared derivatives contracts. An international effort by the [BCBS and IOSCO] is helping to co-ordinate these regional initiatives,” the Bank said in its Financial Stability Report.
However, says ISDA, OTC derivatives market counterparties would have to post over $10 trillion in initial margin if meeting the standard margin schedule put forward by BCBS/IOSCO. This figure could fall to $1.7 trillion if firms used approved internal models or to $800 billion if there was also a €50 million exposure threshold between counterparties before margin payments were required.
“Increased initial margin requirements in stressed conditions will result in greatly increased demand for new funds at the worst possible time for market participants,” ISDA argues.
The trade association says that OTC derivatives contracts should have no mandatory initial margin payments. Instead, says ISDA, only variation margin should be mandatory in non-cleared derivatives, accompanied by mandatory clearing for liquid, standardised products and appropriate capital standards for dealers.
The Bank of England has issued a lower estimate than ISDA for the mandatory initial margin requirements for derivatives traders resulting from new regulations, saying that such payments should reach between US$200 billion and US$800 billion, three quarters of which would be driven by central clearing activity. Calculations of margin requirements are highly sensitive to the assumptions used for the permissible levels of netting between market participants.
It’s not only banks who face an upheaval as a result of regulators’ push to impose minimum margin standards.
Earlier this year European pension funds, who are major users of non-cleared derivatives, gained a three-year exemption from regulators’ central clearing requirements, but face pressure to start posting initial margin for derivatives trades earlier than the date their clearing exemption ends, law firm Slaughter and May warned last month in a briefing note.