Just six banking groups will start posting initial margin on new non-cleared derivatives trades from September, Risk.net has learned – a group with some notable absentees. The deadline marks the start of the margining regime's second phase; the market's largest dealers became subject to the rules last year.
Sources at ANZ, Danske Bank, ING and Nordea have confirmed they will be caught by the rules from September. Well-placed industry sources say Santander and Japan's SMBC are also in scope, but officials at the two banks declined to comment.
The second phase of the rules captures banks with aggregate month-end average notional amounts of non-centrally cleared derivatives for March, April, and May 2017 of more than €2.25 trillion ($2.52 trillion) in the European Union. Similar thresholds apply in countries such as Australia, Canada, Japan and the US. In-scope banks must start posting initial margin on new trades with other entities subject to the initial margin requirement when the rule comes into force on September 1.
At first glance, it may seem odd that firms with more derivatives assets and liabilities than the €140 billion held by Danske Bank are not caught by phase two. However, a number of banks have worked hard to optimise their portfolios to ensure they are not caught by the second phase – a tactic major dealers recommended at a conference last month.
One industry source close to the margin discussions says the next phase of the rules looked set to snare more firms, but those on the boundary have sought in recent months to backload clearable positions to central counterparties and optimise other non-cleared positions in an attempt to reduce notionals.
“A lot that had initially been in scope for phase two figured out ways to get themselves out of scope by clearing parts of their portfolios or reducing [their size],” he says. “People thought: ‘We’re pretty close to the threshold for phase three, so let’s get there.’”
Non-cleared derivatives optimisation services have also reported higher usage from second-tier banks in recent months. “The introduction of phase two of the non-cleared margin rules has prompted more interest in triBalance, TriOptima’s initial margin optimisation service, as well as increased use of our triReduce compression service. To remain under the gross notional threshold for phase two, firms intensified their compression activity and we observe continued take-up for triReduce for phase three,” says Peter Weibel, chief executive of triReduce.
A regulatory source at one bank agreed, saying it had undergone a “significant compression programme” to avoid phase two.
But for at least one of the six banks included in the second phase, previous optimisation efforts meant there was little left to reduce in the lead-up to the initial margin calculation period. “We did a lot of bilateral and triReduce compressions and bilateral backload exercises a long time prior to the initial threshold-measuring window – but unrelated to it. This reduced the amount of low-hanging fruit available to bring us further down,” says a source at one of the banks.
In addition, while the initial margin thresholds are broadly similar across regions, the calculation methodologies for the thresholds differ and do not easily align to reported numbers. For instance, physically settled foreign exchange forwards are included in the EU calculation but not in the US version. The US also exempts trades with end-users such as corporates and small banks from counting towards the threshold, whereas the EU does not.
This may help explain why the likes of Wells Fargo are not caught by phase two, which in the US is set at a threshold of $2.25 trillion (€2 trillion). The bank's first-quarter Pillar 3 report reveals it has $3.44 trillion in notional non-cleared derivative exposures, but it adds that most of its trades are with corporates, which don't count towards the threshold in the US.
The phase-two banks will need to sign initial margin collateral agreements and complete custodian documentation with all major phase-one dealers to secure their supply of liquidity. One Asia-based lawyer warns this will be a significant drain on resources.
“It will be interesting to see how these banks deal with it. They’ll need to paper with all of the phase-one banks for liquidity, so it’s quite a big task,” he says. “It’s a big jump. Initial margin is a totally different beast to variation margin. There are a lot more legal, documentation and operational issues – it’s much more complex.”
Additional reporting by Chris Davis, Frances Ivens, Nazneen Sherif and Robert Mackenzie Smith
Correction, June 15, 2017: The article has been amended to remove a reference to Royal Bank of Canada. The bank was in phase one of the US and EU non-cleared margin rules, not phase three or four as was implied.