Finadium has released a new report on strategic planning for non-cleared derivatives risk-based margining. This report is publicly available with free registration, courtesy of Murex.
When new recommendations on non-cleared derivatives were finalized by the Basel Committee and IOSCO in September 2013, it was the next step in years of efforts on how to protect the financial system from the systemic risk coming from bilaterally traded derivatives. As these recommendations now start to become rules in various jurisdictions, financial market participants must evaluate how to best implement them.
This report focuses on strategies and preparations for risk-based margining and collateral management in the non-cleared derivatives arena. Initial Margin (IM) in particular will change meaningfully as regulators shift to a “defaulter pays” model. The credit exposure that was embedded in bilateral derivatives, and especially those historically without IM requirements, will require a new operationalization of more risk-sensitive collateral management. Variation Margin (VM) siloing by asset class and its inherent complications should also be considered. Banks and investors need to understand what the changes are, if and when those changes impact them, and what choices they need to make as a result.
The new rules will create their own distortions in the market as participants adapt to new cost constraints. The cost of collateral for centrally cleared trades will be regularly compared to the extra expense incurred in non-cleared derivatives. Depending on how the analysis comes out, trades that could remain bilateral may migrate toward execution on CCPs. The risk is that market participants who might otherwise need a bespoke non-cleared solution will head toward centrally cleared products, even if the basis risk between the two is large.
This report provides a robust overview of the Basel Committee on Banking Supervision (BCBS) and International Organization of Securities Commissions (IOSCO) recommendations on non-cleared derivatives margining, and strategies for mitigating the regulatory burden. The intended audience is operations, technology and risk professionals at financial institutions that will be affected by the rules their national regulators put into place, following the BCBS/IOSCO standards. The paper concludes with a checklist of important questions to ask as managers start to prepare for new market-wide practices in non-cleared derivatives margining.