Article: Bilateral Margin Headache Solved

16 November 2015 | James Cherry

Since 2008, regulatory changes to prevent another crisis from occurring have been incrementally rolled out. The US is ahead of Europe with mandated clearing and electronic trade execution already in effect and with trade reporting a requirement in both jurisdictions. From September 2016, Europe will see the introduction of mandatory margining for non-cleared OTC derivatives. Only the largest dealers are in the first wave of firms impacted by the new requirements, but the scope broadens year on year out to 2019 to encompass a wide range of firms active in the OTC derivatives markets.

FREE WEBINAR: Richard Glen, Head of Global Securities Finance Sales plus guest speakers will be presenting a free webinar on to follow on from this article. The webinar will focus on a 'cure' for the bilateral margin headache, and will be held on Tuesday 1st December; to find out more and to register your interest visit the announcement here.

The first wave of firms must exchange both Variation and Initial Margin from likely 1 September 2016, with all firms to exchange Variation Margin from 1st March 2017. The industry is working hard to figure out legal and technical solutions to align portfolios in order to achieve an accurate exposure calculation, as disputes are potentially to be penalised with a significant capital increase through the doubling of the Margin Period of Risk. Forensic methods of uncovering both population and valuation differences beyond anything undertaken so far will need to be found.

New regulations require firms that are bilaterally trading non cleared derivatives to apply a model for Initial Margin calculation which is either a very simple schedule using a percentage of notional, or a super complex Value at Risk approach. A universally unwelcome outcome would be a different Initial Margin calculation from both firms leading to an increased credit exposure. ISDA has been facilitating a solution by promoting the implementation of a Standard Initial Margin Model (SIMM) for use by member firms.

Once firms arrive at a value for the Initial Margin, the process of calling margin, moving assets and observing the regulatory restrictions comes into play. Key challenges include:

  • Agreeing a legal basis to move the assets via an agreed settlement provider
  • Ensuring the two way exchange happens as close to simultaneous as possible
  • Using an agent who can hold the assets in escrow
  • Preventing re-hypothecation, as determined by the regulations
  • Flexibility in the range of assets possible to pledge against the exposure
  • Achieving effective segregation of all asset classes
  • Receiving timely and accurate reporting on the settlement process

The DIY Option vs Clearstream’s TCMS

Lets imagine how a firm would meet the new regulations in-house using their own people and systems and compare this with an outsourced triparty collateral management solution. At a high level, here’s how you might approach the problem (See Table 2)

The burden of investment and implementation falls squarely on each firm to meet the new regulations, as explained below. Clearstream as part of its triparty collateral management offering, provides the necessary technical and operational infrastructure for the segregation and the management of Initial Margin (IM) for uncleared derivatives.

Legal Basis

Traditionally, putting a credit support document in place between two parties involves a bespoke negotiation to try and meet both firms views on what works for them practically and economically. The latest ISDA Margin Survey shows there are nearly 140,000 bilateral margin agreements in place and these potentially need replicating to cover new trades from September 2016 onwards. There doesn’t seem to be a consensus on what works for them practically and economically. The latest ISDA Margin Survey shows there is rapidly gaining traction amongst the dealer community for a multi-lateral pledge agreement provided by Clearstream. Clearstream already offer a multilateral document to meet the needs of clients wishing to transact Triparty Repo in a standardized form (the Clearstream Repurchase Conditions or CRCnse) building upon success in the repo market Clearstream have turned an eye to swaps documentation.

The agreement would provide a common margin agreement which each firm only signs once, rather than signing for each and every bilateral party subject to the new regulations. The document would then automatically extend to any number of counterparties who have also signed it, greatly reducing implementation time. The nature of the agreement is a common framework for the core terms governing the exchange of IM with specific customisation still available for each bilateral party around concentration limits and eligible collateral and haircuts. The Clearstream structure also provides for standardised baskets of assets which can be elected easily, rather than making each relationship bespoke; again this is an area in which a number of dealers are expressing an interest.


One feature of the new regulations is a ban on re-use of assets provided as Initial Margin. In the current environment, under a transfer of title legal structure, an asset received as margin can be treated as fungible and be traded onwards as a receiver sees fit. In the new world, with the legal basis for the transfer of assets being pledge or securities interest, an asset cannot be freely re-used and must remain in the collateral account without being passed to a third party. The asset can be replaced (substituted) with another eligible asset, but otherwise this restriction on re-use must be enforced to remain compliant.

Matching instructions

An indirect outcome under the new bilateral rules would be a new dispute over the amount of IM required by each party. In a perfect world, the IM calculations for both parties produce the same number, but in reality, each firm is free to use either the VaR or schedule based approach and to implement their calculations using whatever software they choose and with whatever market data and scenarios they choose.

Without a central service, each firm ought not to instruct delivery to their counterparty until both sides have made their call, to avoid a credit risk of delivering assets to your counterparty without the expectation of a delivery in return. With a central service, the existence of a pair of margin calls and a comparison of the amount of IM can be performed, leading to the movement of the undisputed amount being the lower of the two IM values. The amount remaining will become a dispute and needs to be resolved.

TCMS provides support for receiving two margin calls, comparing the IM amounts and moving the undisputed amount between the parties. Resolving the dispute then becomes a bilateral exercise between the parties.

Selection of Assets

Once a firm is part of the TCMS platform, and having agreed which assets can be pledged to cover the VM or IM exposure, it is helpful if the selection of assets can include concentration and risk limits for classes of asset. Each receiver may have their own risk tolerance levels for specific issues, assets or groups of assets, which can be cumbersome to apply without automation. TCMS provides tools to handle all these requirements, meeting both parties’ interests, which includes setting a bespoke asset allocation order to find the cheapest-to-deliver securities.

Delivery of Assets

Under normal circumstances the delivery of assets is asynchronous, but with the new regulations requiring two way exchange of IM - you wouldn’t want to deliver assets to your counterparty unless you knew they were delivering at the same time - otherwise there is a credit risk that your counterparty defaults before delivery leaving an uncovered exposure.

TCMS provides for the simultaneous settlement of assets against the two IM requirements and ensures that this is both legally and operationally guaranteed.

Asset Servicing

The regulations require that the assets covering IM are held by an independent party and segregated from other assets in an escrow model. TCMS does exactly this but also handles automatic substitu- tion, corporate actions and reporting in real-time on activity in your account. In addition assets are re-valued daily, and automatically topped up / returned as the market value changes.

Asset Sources

The Global Liquidity Hub provides the ability for a firm to post assets held outside of the Clearstream custody network in favour of exposures managed within the Clearstream network, through a series of reciprocal relationships that Clearstream has in place with local or global custodians (Liquidity Hub Connect). This helps customers seamlessly unlock silos of assets held in various domestic custody arrangements, greatly increasing available inventory and collateral velocity. The Global Liquidity Hub provides the legal and operational means for securities held by a local custodian to be included in the TCMS service, giving a much wider range of eligible assets than those simply held directly within Clearstream. This gives clients of Clearstream the option to use a larger portion of their possible inventory than otherwise would be the case; equities, fixed income securities, fund units and cash are all pos- sible collateral types. With increasing quantities of collateral being locked down for non cleared IM requirements and a focus on the Basle liquidity coverage ratio (LCR) this flexibility offers significant advantages for customers of Clearstream Banking Luxembourg.


Amongst the challenges in implementing the new margin requirements, solving of the post-call process is ready and available now. Firms have just over a year to put new processes and agreements in place, including opening accounts to handle the exchange of IM. At Clearstream, this process is well underway notably with no charge for ‘pre-reservation’ of accounts and the setup of the required operational structure. Bilateral settlement of assets against IM requires firms to handle the asset servicing requirements themselves, whereas TCMS provides a tried and tested full service platform already in operation. Firms can integrate messaging via SWIFT into their own Collateral Management Systems to receive real-time updates on the processes at TCMS, making the service transparent and simple to use.

This article was first published in edition 5 of Rocket, our magazine. Download available Rocket editions here, and save your up to date address in your profile to to indicate your interest in receiving a printed copy of the magazine. Copies are also available to purchase and subscribe to via the shop.

To save your address into your profile:

  1. Visit the home page
  2. Click Account (in the middle of the row of black buttons)
  3. Click Edit Profile (in the row of buttons at the top)
  4. Click Reader (top right)
  5. There you can see your profile, with a box for your address - complete it accurately, and click Save


FREE WEBINAR: Richard Glen, Head of Global Securities Finance Sales plus guest speakers will be presenting a free webinar on to follow on from this article. The webinar will focus on a 'cure' for the bilateral margin headache, and will be held on Tuesday 1st December; to find out more and to register your interest visit the announcement here.