Seeing Double: ISDA Highlights Imminent WGMR Documentation Challenge

March 3, 2015

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In a recent webcast, ISDA highlighted the impact on portfolios of derivative documentation which will result from its various workstreams designed to facilitate compliance with the Working Group on Margining Requirements’ (WGMR) forthcoming rules on margin for non-centrally cleared derivatives. It is required listening for anyone with responsibility for derivative documentation, but a summary is provided below.

The first step on the road to WGMR compliance will require firms to determine which set of margin regulations apply to each of their contractual relationships. In order to do this, counterparties will need to exchange certain key information, including:

Status under the applicable margin rules – e.g. “FC”, “NFC+” or “US Person”;
Average aggregate notional amount of trades outstanding (on a consolidated basis);
Corporate structure; and
Guarantee information.

To assist, ISDA is in the process of developing a self-disclosure form. This will be available as a representation letter or via ISDA Amend.

Subsequently, each firm will be required to identify the exact manner and extent to which it will be impacted by the relevant rules. In turn, this will enable identification of the documents that need to be amended (or negotiated) and the exact amendments that are required. The process of repapering is made more complicated by the fact that rules requiring the posting of variation margin (VM) are currently due to take effect for the entire market on 1 December 2015 whilst the requirement to post initial margin (IM) is due to be phased in over a 4-year period commencing on the same date, but beginning only with the largest derivatives users.

ISDA highlighted CSAs as the main candidate for amendment or negotiation as a result of the WGMR rules. It will publish a new suite of WGMR-compliant CSAs under NY law, English law and Japanese law. It is anticipated that these will be flexible enough to achieve compliance across multiple jurisdictions and will cater for situations where a firm or group is subject to more than one set of rules. The elements of CSAs that are likely to be amended include:

Collateral eligibility;
Haircuts;
Collateral calculations;
Collateral delivery/collection timing;
Dispute resolution; and
IM segregation requirements.

Custodial arrangements (such as ISDA’s tri-party Account Control Agreement) will need to be put into place in order to segregate IM and there was also a suggestion that duplicate ISDA Master Agreements may be required in some jurisdictions.

ISDA is adopting a 2-stage approach to assisting firms comply with the new rules. During the first stage its focus will be on helping firms to ensure that provisions regarding VM are WGMR-compliant. It is anticipated that this will be achieved by way of an ISDA protocol. The protocol will include provisions to allow ‘new’ CSAs (which would apply to transactions executed after the WGMR rules become applicable to the particular counterparty) to co-exist with ‘legacy’ CSAs (which would apply only to transactions pre-dating the introduction of the WMGR rules) under a single ISDA Master Agreement.

In the second stage, ISDA will concentrate its efforts on facilitating WGMR compliance for those firms which (a) are required to post VM under the new WGMR rules; and (b) which are not required to post IM under the WGMR rules, but which do post IM in practice. Two possible approaches are envisaged:

Preservation of existing IM arrangements by duplication in a new CSA which also includes WGMR-compliant VM provisions; or
Leaving existing IM arrangements under an existing CSA and putting in place a new CSA solely for WGMR-mandated VM posting.

Subsequently, ISDA will turn its attention towards those firms that are required by the WGMR rules to post both IM and VM. For these firms, a second new CSA would be added to the documentation suite in order to cover these transactions. In this regard, it is anticipated that parties using an English law CSA would continue to do so for VM but would operate using a CSD for segregated IM.

2015 for documentation teams seems destined to involve an awful lot of head scratching and an awful lot of repapering. Unfortunately, the process of WGMR compliance is not aided by the fact that ISDA’s new suite of template CSAs cannot be finalised before publication of the final WGMR rules – something which is not expected before mid-2015. As such, unless regulators agree to ISDA’s request for a 2-year delay, the time remaining to actually implement necessary changes to documentation portfolios will be incredibly short. This serves to reinforce the fact that plans must be formulated and resources allocated now if firms wish to have any hope of dealing effectively with their WGMR-induced diplopia.