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.

Margin has become a lynchpin of global regulatory efforts to mitigate counterparty credit risk and increase the resilience of financial markets. But in times of stress like the March 2020 dash for cash, margin requirements can quickly spike, creating acute liquidity challenges for some participants. Regulators are looking to address this and have made several policy proposals to improve margin practices – changes that we think, for the most part, will help further strengthen the financial system.

For example, a recent paper by the Basel Committee on Banking Supervision, the Committee on Payments and Market Infrastructures (CPMI) and the International Organization of Securities Commissions (IOSCO) highlighted proposed changes to improve the transparency and responsiveness of initial margin in cleared markets. These include central counterparties (CCPs) making margin simulators available to all clearing members and their clients, disclosing and describing any anti-procyclicality tools, making model documentation available to clearing members and publicly disclosing situations where discretion might be applied to override margin models.

There’s a lot we agree with here. Increased transparency will enable market participants to anticipate and prepare for higher margin requirements during stress periods. This will help avoid situations where firms are caught out and have to quickly sell assets to raise cash, potentially leading to a self-reinforcing spiral of further margin calls and forced asset sales. Having experienced a spate of recent market stresses, including the dash for cash, extreme volatility in commodity markets following Russia’s invasion of Ukraine in February 2022 and the rapid blowout in UK gilt yields later that year, it has become clear this is a risk that regulators and market participants need to take seriously.

As noted in our response to the policy proposals, margin simulators are particularly important, as they allow firms to estimate margin under a variety of conditions. We think these tools should mirror the actual models used by CCPs for their margin calculations, be easy to use and be made available directly to all clearing members and their clients. Given their importance in enhancing financial stability, these tools should be offered by all CCPs, irrespective of their size or the size of the cleared asset class. Similarly, we agree that CCPs should make margin model documentation available to allow clearing members and clients to understand key aspects of CCP models, including calibrations of key model parameters and logic used for the calculation of any additional CCP margin components.

In some areas, however, we feel the proposals could go further. For example, we think CCPs should disclose their approach to procyclicality, with the ability for market participants to feed into that determination. Our buy-side and sell-side working group members have stated they would welcome more stability in initial margin, even though that could mean higher margin levels during benign periods. As such, we would welcome more work on the appropriateness of margin periods of risk and the calibration of anti-procyclical tools to ensure margin doesn’t fall too much during periods of low volatility.

This is an approach more akin to that taken in the non-cleared derivatives market. The ISDA Standard Initial Margin Model (ISDA SIMM) remained robust during the recent stress events, in part due to its intentionally conservative design that helped to dampen procyclicality. Nonetheless, we’ve worked closely with regulators to ensure its continued resilience by reviewing the responsiveness of the model. As part of that review process, we’re preparing to move to semiannual calibration next year to make sure the ISDA SIMM continues to be predictable and risk appropriate in all market conditions.

Margin has become a critical risk mitigant in global financial markets. ISDA’s latest margin survey shows that $392.2 billion in initial margin was posted by all market participants for cleared interest rate derivatives and single-name and index credit default swaps at the end of 2023. A further $1.4 trillion of initial margin and variation margin was collected by 32 leading derivatives market participants for their non-cleared derivatives exposures. However, it’s critical we avoid situations where sudden increases in margin catch people unawares, leading to a liquidity squeeze that can exacerbate market stresses. We think greater transparency of CCP margin models is an important step in that direction.

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