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Uncleared Margin Rules – No Solace in Relief

On 3 June 2019, ISDA, SIFMA and the GFMA wrote a letter to the CFTC, the Fed, the US Treasury, the SEC, the FDIC, the Farm Credit Administration and the Federal Housing Finance Agency seeking clarification that covered swap entities do not have to comply with the documentation requirements of the uncleared margin rules unless the amount of IM to be posted/collected exceeds $50 million.

The letter cited the BCBS/IOSCO guidance statement issued on 5 March 2019, noting that it confirmed that the uncleared margin rules do “not specify documentation, custodial or operational requirements if the bilateral initial margin amount does not exceed the framework of €50 million initial margin threshold”.  The authors also expressed support for the recommendations of CFTC Chairman Christopher Giancarlo contained in his letter of 20 April 2019 addressed to the Fed. This encouraged US regulators to issue “guidance clarifying that a US regulated entity need not have in place systems and documentation to exchange initial margin on uncleared swaps with a given counterparty if its calculated bilateral initial margin amount with that counterparty is less than $50 million”.

The letter also poured cold water on suggestions from some quarters that a “CSA-lite” agreement could be used to collect the data necessary to run IM calculations as a substitute for the negotiation of “full-blooded” CSAs.  This option was regarded as non-viable, mainly because no form of “CSA-lite” document actually exists and also because of concerns that it might bring into question the binding nature of the actual CSA which was subsequently negotiated.

Nothing revolutionary here then you might think. And you would be right.  However, the ISDA/SIFMA letter is interesting not so much for what it does say, but rather for what it does not say.  Previous letters from ISDA and SIFMA have been consistent in their calls for other forms of relief, including (a) raising the IM threshold to $100 billion (from $8 billion), (b) excluding FX from AANA calculations, and (c) sparing non-dealers from IM model requirements currently applied to prudentially regulated firms. It also contrasts with the letter which is reported to have been written by the Managed Funds Association to regulators last month. This is said to have pushed the well-rehearsed case for varied forms of relief hard. Perhaps the only conclusion that can be drawn is that the industry (or at least the sell-side) has given up hope of securing any other form of relief.

Whilst documentation relief is both helpful and appropriate, one can’t help but feel that it misses the bigger point – this being that there is a difference between ‘documentation relief’ and ‘systems relief’. The former is likely to be granted. The second is not. The result is that firms will be left to deal with most of the burden associated with IM anyway.

ISDA and SIFMA rather selectively quote from the BCBS/IOSCO guidance statement, failing to refer to the authorities’ expectation that “covered entities will act diligently when their exposures approach the threshold to ensure that the relevant arrangements needed are in place if the threshold is exceeded”. On the face of it, BCBS/IOSCO does seem to expect firms to implement some kind of process to monitor and manage IM exposures. On that basis, what are the prospects of securing ‘systems relief’ as floated by Mr Giancarlo in his letter?  Slim. ISDA’s own analysis suggests that over 70% of Phase 5 firms may not pass the $50 million threshold and so would not be required to put IM documentation in place (at least not immediately).  Would regulators be comfortable allowing this rump to remain effectively unregulated, however systemically important (or otherwise) individual firms might be? It’s difficult to imagine that they would.

Perhaps regulators will require firms to start the process of documenting their IM relationships after some kind of sub-threshold has been exceeded.  Perhaps they will be comfortable with a more relaxed interpretation – allowing firms to do nothing until the $50 million threshold has actually been breached. Either way, it would seem sensible for authorities to take the next logical step and see fit to grant firms a grace period once the relevant threshold has been exceeded in order to allow documentation to be negotiated and executed. A six-month grace period would not come as a surprise – regulators have previous form here. This was the length of time granted to the industry post-March 2017 to get remaining VM documentation in place. Based on a large number of IM negotiations we have executed to date, this would be more than sufficient – even as the industry enters Phase 5.

In reality, none of this really matters.  The important point is that all of this implies that firms will have to put in place some kind of system to monitor IM exposures so as to enable IM documentation to be put in place in a timely manner once the $50 million threshold (or a sub-threshold) is passed. Given that the IM systems build is a much bigger job than the IM documentation piece, can we really conclude that the industry is benefitting from any kind of meaningful relief? I’m not so sure that it can.

The implications for Phase 5 firms seem fairly clear. If your IM exposure is below $50 million you will probably benefit from some form of documentation relief. However, that is only one piece of a much bigger and more complex jigsaw. Unfortunately, you are unlikely to see much in the way of relief more generally. If you are a Phase 5 firm, your preparations for the September 2020 deadline should already be well underway. Don’t allow the ongoing attempts to seek relief lull you into a false sense of security. Don’t pin your hopes on the 11th hour regulatory reprieve. Don’t take your foot off the gas.

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