On 2 April 2013, the International Organization of Securities Commissions (IOSCO) published a list of the responses it received to its consultation document on margin requirements for non-centrally cleared derivatives, published on 15 February 2013, a more detailed summary of which can be found here. Two notable responses were received from ISDA (primarily for the sell-side), and the Investment Management Association (IMA) (for the buy-side), as detailed below:
Physically-Settled Foreign Exchange
The consultation document had asked whether physically-settled FX forwards and swaps should be exempt from initial margin (IM) requirements. The IMA believes that physically-settled FX forwards and swaps with a tenor of 3 months or less should not be subject to any margin requirements at all, but that the exchange of variation margin (VM) for longer-dated contracts “could be appropriate”. In contrast, ISDA’s position is that physically-settled FX forwards and swaps should be exempt from any margin requirements, irrespective of tenor.
Rights of re-hypothecation
The consultation document had asked whether re-hypothecation should be allowed in order to finance/hedge customer positions. The starting point for the IMA is that re-hypothecation of collateral held for margin purposes should not be allowed at all. In contrast, ISDA believes that customers should be permitted to choose between segregation of IM at the secured party or at a third party, or for full re-hypothecation.
The IMA regards the commencement of the phase-in arrangements (on 1 January 2015) as “appropriate and helpful” whereas ISDA believes that they impose too short a timeframe for compliance and risk exacerbating the liquidity, operational and other implementation issues associated with the IM requirement.
EUR 50 million consolidated IM Threshold
Both the IMA and ISDA express concerns about this proposal. ISDA questions the feasibility of such an arrangement given the different legal and business structures of market participants and differing definitions of ‘consolidation’ across jurisdictions. In a similar vein, the IMA expresses concerns that margin requirements should not be aggregated across sub-funds, which would potentially pierce the legal segregation at the heart of many umbrella fund structures. It also believes that it would be inappropriate to attempt to aggregate group exposures if this would require the client business of an asset management company (which would be off-balance sheet for the asset manager) to be aggregated with the holdings of any bank/insurance company parent or affiliated company.
Initial margin generally
ISDA reiterated its in-principle opposition to the IM requirements, which it believes are misguided for the following reasons:
- Amount of Margin Requirement: ISDA believes that the proposed level of IM is too high, would severely reduce the use of uncleared OTC derivatives and would create a funding requirement on the part of market participants the effect of which would be to reduce overall business activity and damage the real economy;
- Pro-Cyclicality: ISDA considers that the IM model proposed in the consultation document will have a pro-cyclical effect in times of significant stress;
- Practical Obstacles: ISDA believes that the requirement to post IM will impose significant operational burden on market participants which have not posted IM in the past and will result in a significant numbers of disputes, especially if VaR models are used; and
- Effective Mitigation: Instead of requiring IM, ISDA considers that systemic risk can effectively be mitigated by a combination of:
- VM requirements;
- appropriate capital requirements; and
- mandatory clearing of liquid, standardized OTC derivatives.