Get Ready for Phase Five, Get Set for Phase Six

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.

With the arrival of summer in the northern hemisphere, July and August tend to be relatively quiet months in finance. But scratch beneath the surface of the derivatives market and you will find a large group of market participants busy getting ready for a seismic change.

On September 1, the global initial margin (IM) requirements for non-cleared derivatives will extend to all entities with an average aggregate notional amount (AANA) of non-cleared derivatives greater than €50 billion. This is the fifth phase of the implementation that began in 2016 and is expected to sweep hundreds of new entities into scope – ISDA analysis in 2018 put the number at more than 300.

That’s a massive shift given the first four phases captured somewhere between six and 20 firms at a time. Add in the diversity of market participants – asset managers and pension funds, rather than just banks, will be caught by this phase – and the scale of phase five becomes clear. As the requirements extend to smaller entities, the compliance challenge for individual firms increases.

Exchanging IM in line with the requirements is a project that requires diligent preparation over a period of at least nine to 12 months to make sure relationships with custodians are in place, documentation is negotiated, and all the relevant systems and processes are fully tested. By this stage, firms that expect to be caught by phase five should be very well advanced so that the remaining weeks can be devoted to final snags and testing.

ISDA has long understood the operational challenges that phase five would pose. We are grateful that regulators recognized this back in 2019 with the creation of an additional phase for smaller entities, reducing the risk of a huge compliance bottleneck. In April 2020, the implementation of phases five and six was rightly delayed by a year so that firms could channel critical resources towards business continuity and risk management during the pandemic.

Regulators have made very clear there will be no further relief or extensions, and while phase five is certainly a challenge, we recognize the onus is now on the industry to meet the September 1 deadline.

ISDA has worked with market participants on these requirements since well before the first phase of counterparties began posting IM in 2016. Industry tools including the ISDA Standard Initial Margin Model and ISDA Create have been critical in supporting effective and consistent implementation. Resources to support implementation and help firms make the necessary technological and operational changes are available via the ISDA Margin InfoHub.

It is in the nature of major regulations that one must start preparing for the next hurdle while still clearing the current one. With only six weeks to go until the phase-five deadline, this is the time to be thinking about phase six, which applies from September 1, 2022 for all entities with an AANA of more than €8 billion. Our 2018 analysis suggested this would apply to a further 775 entities – this is well over double the number in phase five and likely to include a larger number of small non-bank entities.

We know from the experience of the early phases that it is never too early to start preparing, given the operational complexity of IM exchange. So, with a year and six weeks to go until the toughest phase of all, let’s make sure we prepare early and efficiently to create a safer derivatives market for everyone.

Listen to the latest episode of The Swap podcast, which explores phase-five and six implementation issues.   

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