On 7 November 2014, ISDA published version 1.0 of its “Minimum Standards for the Future State of Margin Workflow” (the “Standards”), a working document designed to support practical implementation of the BCBS-IOSCO margin requirements for Non-Centrally Cleared Derivatives and the draft EU Regulatory Technical Standard on Risk-Mitigation Techniques for OTC-Derivatives Contracts not Cleared by a CCP (the “Rules”).
The Standards will be revised following publication of final rules by the CFTC, SEC and US Prudential Regulators. It is currently divided into 5 parts:
- Counterparty setup and client on-boarding;
- Trade execution;
- Initial Margin (IM) and Variation Margin (VM) calculations, composite margin notifications and settlement provisions;
- Collateral eligibility; and
Broadly, the Rules require all financial firms and systemically important non-financial counterparties to exchange IM and VM with respect to any non-centrally cleared derivatives. Despite the fact that the Rules are unlikely to be finalised until April 2015, the requirement to post VM will take effect as of 1 December 2015. The requirement to post IM is to be phased in from December 2015 over a four-year period, beginning with the largest firms.
The Standards cast a harsh light on the legal and documentation challenge facing firms in their attempts to comply. The most significant development is undoubtedly the widely held assumption that, in the new world, two credit support annexes will be required for each counterparty relationship – one to deal with pre-implementation transactions, the other to deal with post-implementation transactions. Other significant aspects include the requirement to:
- Document counterparty obligations to disclose legal entity information;
- Renegotiate legal documentation and enhance legal data capture systems to improve a firm’s ability to consume additional data, including:
- Legal entity information;
- Identification of relevant collateral agreements and in-scope products;
- Documentation of bifurcated IM and VM calculation methodologies, including Threshold and Minimum Transfer Amount elections;
- IM and VM eligible collateral;
- Collateral concentration limits and haircuts; and
- Methods of segregation and custodial arrangements;
- Document margin terms prior to trade execution; and
- Allocate individual transactions to correct CSA.
Despite looming deadlines, the Standards acknowledge that a number of solutions cannot be developed until certain aspects of the Rules are clarified. Outstanding questions include whether counterparties can net 2 CSAs under an ISDA Master to reduce the volume of collateral payments, and whether the concept of multiple CSAs will work if legal advice recommends modifying existing CSAs instead of putting in place a new CSAs. ISDA has asked for more time – specifically that IM requirements take effect two years after the rules become final in the US, EU and Japan and that VM requirements are phased in over the same two year period – but the chances of a postponement seem slim at best. There is also some suggestion that ISDA will attempt to create a protocol to avoid manual execution of CSAs for VM purposes, but the assumption seems to be that a number of other aspects will remain to be documented bilaterally, including eligible collateral, haircutting methodologies, concentration limits and custodial arrangements. Either way, one thing is certain – an enormous amount of resource will be required in order to amend documentation portfolios and upgrade legal data capture systems in order to comply with the Rules. On the bright side, ISDA has provided a very useful tool for those in need of a route-map to compliance. Unfortunately, those with the greatest need for such a document may already find themselves with too little time to formulate and execute a plan to comply.