ISDA Chief Executive Officer Scott O'Malia offers informal comments on important OTC derivatives issues in derivatiViews, reflecting ISDA's long-held commitment to making the market safer and more efficient.
This matters because inter-affiliate trades are used by firms to centralize their risk management activities. These internal risk management transactions do not create new counterparty exposures outside the corporate group – in fact, centralizing all the risk in a single risk function creates efficiencies and ultimately limits credit exposure to third parties.
Many global regulators recognize this, including the US Commodity Futures Trading Commission, which, under both a Democratic and Republican chair, has maintained exemptions for inter-affiliate trades in its IM rules. This bipartisan support also extends to Congress, where both Republicans and Democrats have written to US prudential regulators voicing their support for a rule change.
This isn’t a new concern. Even back in 2015, a bipartisan letter on inter-affiliate IM requirements was sent by the House Committee on Agriculture raising concerns that “additional costs could be passed on to a bank’s uncleared swap customers, often end users, without making these trades safer”.
These are important points. Requiring IM for inter-affiliate transactions diverts resources from being used elsewhere, and also puts firms subject to US rules at a competitive disadvantage. At year-end 2018, the top 20 derivatives dealers had posted approximately $39.4 billion in inter-affiliate IM.
Now, some commentators suggest any attempt to change the inter-affiliate IM requirement represents a weakening of risk management and a roll back of the regulatory framework. That neglects the fact that IM requirements for external-facing trades – the source of exposure to third parties – would not be affected. According to the latest ISDA margin survey, the top 20 dealers held $157.9 billion for their non-cleared derivatives transactions at year-end 2018 (that doesn’t include inter-affiliate IM). That’s on top of $858.6 billion in variation margin collected by the largest 20 firms.
By obtaining an exemption for inter-affiliate trades, firms would essentially avoid having to post and collect duplicate IM amounts – once for the external facing trade and again for the internal risk transfer within the corporate group. That’s an extremely inefficient use of resources.
Margin requirements are an important part of the regulatory reforms that have made the derivatives market safer and more resilient. There’s no appetite to reverse the important changes that have taken place, like clearing, reporting, margin and capital requirements. But there is an opportunity to improve the rules and make them consistent across jurisdictions. This will make the framework more effective and more efficient.