InteDelta: A Commentary On Issues For Centrally Cleared And Non-Cleared Business
Posted: 8 October 2013
The financial crisis revealed major weaknesses in the global financial system, particularly in the interdependence between large financial institutions. A number of regulatory initiatives are in the process of being put in place to reduce the overall counterparty risk in the system. Most significant is the move to central clearing of OTC derivatives. A key risk mitigating feature of central clearing is the requirement to post Initial Margin (IM) to Central Clearing Counterparties (CCPs). Rules have also been produced requiring IM to be posted bilaterally between counterparties for transactions that are not subject to central clearing. This paper examines the management of IM for both cleared and non-cleared OTC derivatives. The diagram below summarises the high level processes an institution needs to follow in the management of IM.
The regulatory drivers will first be discussed followed by each of the above processes. Finally, the features of a Target Operating Model (TOM) that an institution should adopt to bring together the organisational model, systems architecture and processes to manage IM are described. Background and regulatory drivers
An understanding of IM requirements must first start with the regulatory initiatives driving the change.
After the 2008 crisis the G20 initiated the move towards central clearing. In Europe this became enshrined in the European Market Infrastructure Regulations (EMIR) whilst the US adopted the Dodd Frank Act. Equivalent regulations are also being imposed around the world e.g. in Hong Kong, Singapore and Australia. This paper will focus mainly on the European situation. EMIR is a wide ranging regulation and this paper will only refer to the aspects that impact IM. Also of relevance are the recommendations by the Working Group on Margin Requirements (WGMR)1 that cover transactions which will not be subject to central clearing. IM has long been a feature of the financial markets. It was originally best known in the context of exchange traded derivatives and cash equity where exchange members must make an upfront payment of IM to the exchange and also settle daily Variation Margin (VM). In the OTC world the concept of IM has historically been less well developed although is economically similar to the Independent Amount (IA) under a Credit Support Annex (CSA) (using ISDA collateral terminology). In financing transactions such as securities lending and repo the Margin Ratio (MR) is also economically similar to IM.