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The ISDA 2016 Variation Margin Protocol: Boldly Going Where No Protocol Has Gone Before

The Final Frontier

On 17 November 2016, ISDA published a “Supplemental Rules Exhibit” (the “EMIR Supplement”) to the ISDA 2016 Variation Margin Protocol (the “Protocol”).  The purpose of the EMIR Supplement is to enable adherents to the Protocol to integrate amendments for margin rules for OTC derivatives in order to achieve compliance with EMIR[1] into their CSA documentation.

Section 7 of the Protocol empowers ISDA to supplement the Protocol by producing additional documentation (called “Supplemental Protocol Exhibits”).  Any party wishing to take advantage of a new “Covered Margin Regime” created via the Supplemental Protocol Exhibits must complete and exchange a “Supplemental Questionnaire” with its counterparty in accordance with the standard procedure described within the Protocol.  In the context of the EMIR Supplement, exchanging parties are considered to have ‘matched’ questionnaires when any relevant conditions specified in the EMIR Supplement have been satisfied, these conditions being that:

  • The party identified as the deliverer of a Supplemental Questionnaire must also be a recipient with respect to the other Supplemental Questionnaire which has been exchanged;
  • At least one of the exchanging parties must have selected “EMIR Rules” within its Supplemental Questionnaire;
  • The Supplemental Questionnaires must match (we have a process flow diagram for helping determine when an exchange of questionnaires (including EMIR Supplemental Questionnaires) constitutes a ‘match’ – if you would like a copy, please email me at; and
  • If, under the Protocol, the “Agreed Method” to amend relevant CSAs is “New CSA” the exchanging parties have not selected “Yes” under “Regime Agnostic CSA”.

“Ya canna change the laws of physics captain!”

The classic mass-production, large-batch processing principles which sit at the heart of all ISDA protocols work well if the objective is to effect simple amendments on a large scale.  Unfortunately, WGMR is not simple.  Quite the opposite.  Intuitively, we may be tempted to conclude that a protocol approach is more efficient.  Unfortunately, it isn’t.  To give you some idea as to why, consider the documentation structure that has been created, as depicted in the schedule to this article.  The diagram highlights the fact that, in order to understand the details of any new contractual arrangement executed under the auspices of the Protocol, it is necessary to read master agreements and CSAs against at least three sets of additional documentation, each of which rely on – and cannot be fully understood without – the others.   The situation is complicated yet further by the fact that there may be multiple documents within each ‘set’ and many of those documents are themselves quite complex in nature.

More challenging still is the situation for those acting in the capacity of an agent.  An Adhering Party acting as an agent can deliver both the ‘normal’ Protocol Questionnaire and an EMIR Supplemental Questionnaire on behalf of all or only some of the principals for which it acts and can address those same questionnaires to all, or only some, of the principals for which the receiving party acts.  Thus the number of documents which, in reality, must be read and understood against each other could be many times larger but is not readily ascertainable.

The point is that, in any event, achieving WGMR compliance is going to be a time-consuming and complex affair.  Unfortunately, crow-barring compliance efforts into the framework of a protocol won’t make the task any easier.  It will simply introduce more layers of complexity.  It will do more to obfuscate than to clarify and assist.

“She canna take any more…she’s gonna blow!”

Even more worrying than the complexities associated with the Protocol document structure are the barriers to understanding which that complexity creates.  Put simply, the Protocol is getting too complicated for its own good and is creating risk for adherents in the process.  As an example, Paragraph 4(b)(vii) of the Protocol states that it is a condition of matching that:

  • Where the parties have chosen “New CSA Method” (i.e. where the parties have an existing CSA but want to create a wholly new WGMR compliant ‘bookstore’ CSA to sit next to the original); and
  • Neither party has selected a “Covered Regime”; then
  • Both parties must select “Yes” under “Regime Agnostic CSA?” in order for a match of that original Questionnaire to occur (a “Regime Agnostic CSA” has terms that are intended to provide for compliance with applicable margin regulations generally, rather than for a specific “Covered Regime”).

Under section 2(c) of the EMIR Supplement, it is also a condition of matching an EMIR Rules Supplemental Questionnaire that the exchanging parties have matched ‘original’ questionnaires.  Therefore, it logically follows that it should be a condition of having a matched EMIR Rules Supplemental Questionnaire that both parties have answered “Yes” to the question “Regime Agnostic CSA?” in their ‘original’ questionnaires.  However, at least at first glance, the complete opposite is the case.  Pursuant to Section 2(d) of the EMIR Supplement, it is actually a condition of matching an EMIR Rules Supplemental Questionnaire that the exchanging parties have “not both selected “Yes” under “Regime Agnostic CSA?” (i.e. that at least one of them has selected “No” to the question “Regime Agnostic CSA?”) in their Matched Questionnaires”.  The problem is summarised in the table below:

Elections for “Regime Agnostic CSA?”

Party A Party B ‘Original’ Questionnaire EMIR Supplemental Questionnaire
Y Y Necessary but not sufficient condition for Matching Questionnaire No Matched Questionnaire (?)
N N No Matched Questionnaire Necessary but not sufficient condition for Matching Questionnaire
Y N No Matched Questionnaire Necessary but not sufficient condition for Matching Questionnaire
N Y No Matched Questionnaire Necessary but not sufficient condition for Matching Questionnaire

In these circumstances, has matching taken place or not?  On balance, it probably does, but the situation is wholly unclear and this is an inference at best.  If one assumes that the “Covered Margin Regime” election of “EMIR Rules” by a party in the EMIR Supplement effectively overrides a previous “Covered Margin Regime” election of “None of the Above” by that party in its ‘original’ questionnaire and that this transforms a previously positive “Regime Agnostic CSA?” election under the ‘original’ questionnaire into a negative “Regime Agnostic CSA?” election for the purposes of the EMIR Supplement, then the matching condition under Section 2(d) of the EMIR Supplement is satisfied.  Not that any of this is made clear within the Protocol.  Moreover, whilst this is a fundamentally important question as it pertains to questionnaire matching, the answer is not as important as the more general issue it highlights…

“The needs of the many outweigh the needs of the few…”

The Protocol shouldn’t be this difficult to work out.  The mental gymnastics necessary to properly understand the position across so many documents is too much.  It is not that it’s absolutely unfathomable, but it’s just too complicated to be practical and introduces unnecessary risk into an already uncertain area.  To make matters worse, this may also very well be the thin end of the wedge.  Particularly in light of Brexit and political developments in the US, it will inevitably become necessary to amend these protocol-created ‘virtual’ CSAs in the future.  How this will be safely and efficiently achieved is anyone’s guess, but everyone’s problem.  You are left wondering whether we are just kicking the can down the road and saving up a larger problem for another day.  Do yourself a favour.  Grasp the nettle.  Amend your documents the old way.  You will be grateful you did.

Schedule: ISDA 2016 VM Protocol Structure

[1] Specifically, the regulatory technical standards on risk-mitigation techniques for OTC-derivatives contracts not cleared by a central counterparty which were adopted by the European Commission on 4 October 2016

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