The Financial Stability Board (FSB) released for consultation proposed measures to enhance the liquidity preparedness of non-bank market participants for margin and collateral calls during times of market-wide stress. It identifies weaknesses in risk management and governance as key causes of inadequate liquidity preparedness by some non-bank market participants during recent incidents of liquidity stress in financial markets.
Report proposes eight policy recommendations focused on managing and mitigating the impact of spikes in margin and collateral calls in the non-bank financial intermediation (NBFI) sector, covering liquidity risk management and governance, stress testing and scenario design, and collateral management practices of non-bank financial institutions, focusing on liquidity risks arising from spikes in margin and collateral calls.
These recommendations apply to non-bank market participants that may face margin and collateral calls, including insurance companies, pension funds, hedge funds, other investment funds and family offices. The report also highlights the need for financial intermediaries in bilateral transactions with non-financial entities, such as commodities traders, to consider assessing their liquidity preparedness for spikes in margin calls and collateral during times of stress
Collateral management automation
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. During these episodes the sudden increases in margin and collateral requirements were sometimes significant in scale and frequency, stretching some market participants’ ability to manage the associated liquidity risks.
These events illustrate that whilst margin and collateral calls are a protection against counterparty risk, they can also amplify the demands for liquidity across markets and market participants if they are unexpected in times of stress and affect a large enough part of the market The increase in margin and collateral calls can impact market participants differently depending on the size of their positions and level of liquidity preparedness. This highlights the need for market participants to be well prepared to meet these calls.
Jo Burnham, Risk & Margining subject matter expert at OpenGamma, said in emailed commentary: “There have been multiple stress events over the last half-decade that have exposed the need for many non-bank financial institutions (NBFIs) to improve their liquidity risk management practices.
“The FSB has hit the nail on the head in recognizing that NBFIs want to be proactive in enhancing their own collateral management processes. The ability to robustly stress test operational capabilities regularly is incredibly important if we are to learn from the issues suffered by certain commodities traders in March 2022, or the difficulties experienced by LDI funds and their participants during the Gilts crisis later that year.
“It is correct that the FSB has made a recommendation for firms to consider automating their collateral management processes to reduce the possibilities of operational failures during stress periods. The times when flaws in these systems are exposed are invariably the times where you need them to hold up the most.”