- Policy recommendations aim to enhance the liquidity preparedness of non-bank market participants for margin and collateral calls in centrally and non-centrally cleared derivatives and securities markets.
- Recommendations follow public consultation and focus on liquidity risks arising from spikes in margin and collateral calls, including during times of market-wide stress.
- Recommendations cover liquidity risk management and governance, stress testing and scenario design, and collateral management practices of non-bank market participants.
The Financial Stability Board (FSB) published policy recommendations to enhance the liquidity preparedness of non-bank market participants for margin and collateral calls in centrally and non-centrally cleared derivatives and securities markets (including securities financing such as repo).
The recommendations respond to calls for regulatory adjustments to deal with liquidity strains in the non-bank financial intermediation (NBFI) sector arising from spikes in margin and collateral calls during market stress. The recommendations are intended to build on and complement rules and regulations for liquidity risk management and governance that already exist in many sectors and jurisdictions.
Derivatives and securities activities can expose market participants to margin and collateral calls. Recent episodes of market stress, including the March 2020 market turmoil, the Archegos failure in March 2021, the 2022 turmoil in certain commodities markets, and the September 2022 issues experienced by many pooled liability-driven investment (LDI) funds, underscore the importance of margin and collateral calls to financial stability and the need for market participants to be prepared to meet these calls.
The FSB’s eight policy recommendations cover liquidity risk management and governance, stress testing and scenario design, and collateral management practices of non-bank market participants, focusing on liquidity risks arising from spikes in margin and collateral calls during times of market-wide stress.
The recommendations cover both centrally and non-centrally cleared derivatives and securities markets and apply to a broad range of non-bank market participants that may face margin and collateral calls, including insurance companies, pension funds, hedge funds, other investment funds, and family offices.
Non-financial entities such as commodities traders can also have material derivatives and securities exposures. While the recommendations do not directly apply to such entities, they and their counterparties could use the recommendations to improve their liquidity management and governance practices.
Liquidity risk management practices and governance
Recommendation 1: Market participants should incorporate the assessment of liquidity risks arising from margin and collateral calls in their liquidity risk management and governance frameworks.
Recommendation 2: Market participants should define their tolerance for liquidity risk arising from margin and collateral calls and establish contingency funding plans to ensure that liquidity needs arising from these calls can be met, including under extreme but plausible stressed conditions.
Recommendation 3: Market participants should regularly review and update their liquidity risk framework to ensure that liquidity risks arising from margin and collateral calls are robustly managed and mitigated, particularly under extreme but plausible stress scenarios.
Liquidity stress testing and scenario design
Recommendation 4: Market participants should conduct liquidity stress tests to identify sources of potential liquidity strains caused by margin and collateral calls, and to ensure a level of resilience consistent with their established liquidity risk tolerance. The stress test results should be used to calibrate adequate, diverse, and reliable sources of liquidity and collateral arrangements.
Recommendation 5: Robust stress testing should analyze a range of extreme but plausible liquidity stresses caused by changes in margin and collateral calls, as well as market participants’ overall liquidity position.
Collateral management practices
Recommendation 6: Market participants should have resilient and effective operational processes and collateral management practices.
Recommendation 7: Market participants should maintain sufficient levels of cash and readily available as well as diverse liquid assets and establish appropriate collateral arrangements to meet margin and collateral calls.
Recommendation 8: Market participants should have active, transparent, and regular interactions with their counterparties and third-party service providers in collateralized transactions to ensure adequate operational resilience with respect to spikes in margin and collateral calls under stressed conditions.
Jo Burnham, margin expert at OpenGamma, said in emailed commentary: “The FSB is spot on with its recommendations for NBFIs, who can greatly minimize liquidity risks by regularly stress testing their operational capabilities to efficiently meet their margin calls. After all, the various stress events that created huge spikes in margin costs over the last four years were not black swan events – they reflect the vulnerability that the global financial system continues to have when it comes to liquidity strains. By taking the steps to proactively enhance their own collateral management processes, non-banks can ensure they have enough liquidity available to ride out the storm without causing a bigger problem in the market.”