IM Phase 5 to bifurcate

Confirming recent market rumours, BCBS\IOSCO have today announced their recommendation to stagger IM Phase 5 implementation over a two year period. An adjusted Phase 5 will apply to firms with an AANA equal to or greater than USD\EUR 50bn and less than 750bn.

A new Phase 6, from 1 September 2020 to 1 September 2021, will apply to firms with an AANA equal to or greater than USD\EUR 8bn. and less than 50bn. BCBS\IOSCO’s role is confined to advice (albeit highly persuasive), the timeline alteration would be effected by the relevant Regulators. In the EU, the adjustment would require approval by the three European Supervisory Authorities ESAs- ESMA, EIOPA and the EBA; in the US, the CFTC is no stranger to no-action letters. Partial postponement is unlikely to require time-consuming alteration to primary legislation.

“Further, the Basel Committee and IOSCO have agreed to extend by one year the final implementation of the margin requirements. With this extension, the final implementation phase will take place on 1 September 2021, at which point covered entities with an aggregate average notional amount (AANA) of non-centrally cleared derivatives greater than €8 billion will be subject to the requirements. To facilitate this extension, the Basel Committee and IOSCO also will introduce an additional implementation phase whereby as of 1 September 2020 covered entities with an AANA of non-centrally cleared derivatives greater than €50 billion will be subject to the requirements. “

Earlier speculation predicted a simple(minded) 12 month deadline delay, which would have likely resulted in phase 5 being demoted down a long and growing list of regulatory imperatives. The dual approach at least goes some way to converting the phase 5 cliff edge to two vertiginous steps. Beleaguered legal and operational teams shouldn’t start booking holidays; the light at the end of the tunnel is likely to be the Libor train which is already shaping up to be potential wreckage. The new phase 6 September 2021 deadline virtually coincides with the projected final death throes of the “world’s most important number”, splitting focus while more than doubling the workload.  

The guidance builds upon the BCBS\IOSCO March 2019 statement “clarifying” that documentation and custodial arrangements do not technically need to be in place until the EUR/USD 50m IM counterparty exposure threshold is breached, along with the expectation of “diligence” as they “approach” the trigger (scare quotes indicate a degree of opacity as to definition). Implementation has been slow to date, with only Canada’s OSFI and the CFTC echoing the guidance. By contrast, today’s statement is clear and substantive, we may expect a more rapid Regulatory response, one would hope before 1 September.

It is unclear how the newly in scope population will be distributed across the two new phases. Earlier analysis by ISDA in support of advocacy to raise the threshold to 100bn. estimated that this would exclude 83% of the projected 1,100 entrants.   A 50bn threshold will clearly comprise a higher number than 187, but the population is heavily skewed to the smaller notionals. As a conservative working assumption, it would be reasonable to take the estimated 275 who will already be in breach of the 50m threshold as comprising the adjusted phase 5 population. This then leaves the remainder of 825, from which 50% may be practically excluded as never in danger of breach and therefore disinclined to diligently put IM arrangements in place. This equates to a (very) estimated 275 for phase 5, and 413 for phase 6 which are likely to have crossed or be approaching the threshold by the 2021 deadline. ISDA will doubtless be providing more exact analysis in short order.

Unlike its previous incarnation, this is mitigation worthy of the name. Breaking the phase 5 monolith into two significantly increases digestibility. Conflating the IM timeline with the benchmark reform juggernaut undoes much of this good work. The IM message remains essentially unchanged, start early, avoid the stampede; following today’s statement, it needs saying twice.

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