Following the financial crisis of 2008/09, financial regulators worldwide put in a series of measures to ensure similar crises would not happen again. As a consequence, countries across the world agreed that improved transparency and regulation was needed in the uncleared derivative markets to limit risk-taking and to mitigate the systemic risk posed by OTC derivatives transactions.
One such reform determined that uncleared derivative contracts should be subject to initial margin (IM) requirements and this has been introduced in six waves, starting in 2016, with the sixth and final wave on September 1st 2022. Firms with an aggregate average notional amount (AANA) of uncleared derivatives exceeding €8 billion will be subject to the ‘initial margin requirements’, as stated in the Basel Committee on Banking Supervision (BCBS) and the International Organisation of Securities Commissions (IOSCO) Initial Margin Standards document.
Thus as of 1st September 2022, firms above the €8 billion threshold will be subject to initial margin requirements for uncleared products
What market participants need to know about the initial margin requirements:
Did you know you may not need to put initial margin arrangements in place?
- Whilst your AANA may be above the threshold (2022: €8 billion) and therefore in scope, if your IM is anticipated to remain below €50 million after the go-live date then there is no need to put contractual documentation and custodian arrangements in place. This can be delayed until your IM is expected to go above €50 million
- The BCBS/IOSCO statement from the 5th March 2019, and also the European Supervisory Authorities’ Final Report to the European Commission of 19th December 2019, state that “… the framework does not specify documentation, custodial or operational requirements if the bilateral initial margin amount [amount of IM each party is required to post] does not exceed the framework’s €50 million initial margin”
- However, it is important that both parties have a robust control framework in place that allows them to monitor their IM exposure to allow plenty of time to implement the necessary IM arrangements
What are the deadlines?
- Whilst the remaining regulatory deadline is the 1st September 2022, there are in fact much earlier deadlines which are just as critical and have to be observed. These are the custodian deadlines and are typically set by custodians many months before 1st September to make sure the operational framework is in place on their side
- Each custodian will have their own deadlines which normally cover:
- Onboarding of new clients. The custodian will have its own requirements to onboard and approve new clients, these take a minimum of three months to complete
- Submission of collateral schedules. These need to be agreed by both parties and then submitted to their respective custodians
- Account Control Agreements. These are specific for each custodian
- For 2022, the custodian deadlines can be a shock for the unaware. Different custodians have set different deadlines; the earliest was 28th Feb 2022 and others continue into March and April. If these deadlines are missed, then the custodians may only operate on a best efforts basis to open accounts by the regulatory deadline
- The reason for this is simple; if custodians waited until July, or even August, it would be impossible for them to cope with the thousands of documents from their clients and to create and distribute new accounts to clients. Therefore when planning IM projects, these deadlines should be tracked carefully
How does it work where a fund has multiple investment managers?
- IM gets even more complicated where, for example, a pension fund has multiple investment managers (also known as Separately Managed Accounts). In this example, the pension fund will need to aggregate all trading conducted on its behalf by its investment managers to calculate whether the fund exceeds the threshold (€8 billion)
- If the fund decides it is in scope, then this will need to be communicated to each investment manager and thresholds will need to be allocated among the managers. This could have a P&L impact (i.e. the cost of funding additional collateral if they have a low threshold allocated to them)
- The sell-side will also have a challenging job as each investment manager could require bespoke documentation, particularly if different custodians are being used. Extreme caution will be required as some investment managers may not be aware of each other, furthermore the dealer may not have a relationship with all of the managers and so will depend on the fund owner to coordinate thresholds and other matters
Contact your dedicated BNP Paribas team for more information and advice