Six months ago, the industry was facing the possibility of real disruption. With the variation margin ‘big bang’ set for implementation on March 1, but with only a fraction of the necessary changes to documentation completed, there was a very material risk that a large part of the market wouldn’t be able to trade.
Fortunately, regulators across the globe provided forbearance that allowed parties to continue trading under their existing documentation, providing extra time for firms to continue the lengthy and complex process of amending or creating credit support annexes (CSAs) with in-scope counterparties. That extra time was critical, as final national rules had only been published just months earlier in some cases, leaving a very small window for firms to complete what was essentially a colossal repapering exercise.
With the forbearance set to expire in certain jurisdictions, including the US, on September 1, the industry is in a much better position than it was earlier this year. At the end of February, the estimated proportion of required CSA amendments that had been completed stood at one third. That had reached 90% by the week ending August 11. The 60-odd percentage-point increase represents tens of thousands of newly amended CSAs, each requiring hours and hours of complex bilateral negotiations with counterparties to agree the changes.
That doesn’t mean the job is done, and it doesn’t mean the industry is getting complacent. There’s still a tail of mostly smaller firms that needs to be worked through in the coming weeks and months. These include those counterparties that were operationally unable to support the new regulatory compliant terms until recently, or those cases where bilateral negotiations to amend CSAs have been particularly complex. ISDA will continue to monitor progress right through to September 1, and will share those results with regulators.
But there’s little doubt the extra six months was absolutely vital and averted what could have been a big problem on March 1. Regulators deserve credit for addressing the concerns by providing forbearance – and the industry has worked diligently to make the necessary changes during that time.
The question is what happens to those trades executed after March 1, in line with the regulatory forbearance, but where CSAs have not yet been amended? The industry is working on the basis that those trades will need to be unwound if they are not subject to regulatory compliant variation margin CSAs by September 1. Given firms lack a contractual mechanism to unilaterally force their counterparties to unwind, it will take time to negotiate the terminations – but firms want to be able to demonstrate they’ve been working to tackle the issue in advance.
The rollout of the variation margin requirements doesn’t mark the end of the non-cleared margin implementation effort. The European Union (EU) will bring physically settled FX forwards into scope of the non-cleared margin rules from January 3 – the only jurisdiction to do so – which will result in another wave of CSA negotiations. While a small number of so-called phase-two firms will post regulatory initial margin from September 1, a larger number of counterparties are set to follow suit in September 2018, 2019 and 2020. On top of that, ISDA is preparing to launch the next iteration of the ISDA Standard Initial Margin Model – ISDA SIMM 2.0. That goes hand in hand with the successful operation of the ISDA SIMM governance structure – the mechanism for industry feedback and regulatory review has worked as planned.
ISDA’s work will persist as the rules continue to evolve. That includes the monitoring of preparations for the EU FX and phase-three initial margin implementation deadlines, the development of any necessary documentation solutions, and ongoing updates to the ISDA SIMM. ISDA is committed to working with the industry to develop solutions to help firms with their compliance efforts.