Failure to exempt nearly 1,000 end-users from posting and receiving initial margin from 2020 could introduce unnecessary systemic risk into the over-the-counter derivatives market, according to a senior executive at Bank of America Merrill Lynch.
“[This issue is] another systemic risk that could be caused by the onerous implementation and cost [of the rules],” said Tomo Kodama, a managing director in counterparty portfolio management at BAML, speaking at an event hosted by the International Swaps and Derivatives Association in New York on October 4.
Darcy Bradbury, an Isda board member and managing director at hedge fund DE Shaw, who was also speaking at the event, said she was concerned smaller buy-side firms would find it difficult to access certain derivatives markets should regulators not act.
“The thing I’m worried about as well is not just the implementation, it’s what this means for the market overall. In the same way that firms are finding their access to clearing services is being rationed because of cost, there could be the same impact in this market, where it just becomes too expensive for dealers,” she said.
The non-cleared margin rules, which require covered parties to a new trade to post initial margin to a custodian from the outset, is being phased in over a five-year period. Starting in September 2016, the phase-ins to-date have predominantly affected large banks, though Brevan Howard became the first buy-side firm to be caught when the third phase came into effect last month. So far, just 37 firms have been affected by the rules, according to Isda chief executive Scott O’Malia.
The industry fears that the fifth phase, due to come into effect in 2020, will capture significantly more.
An analysis of more than 16,000 legal counterparties, led by Isda, shows that around 1,100 buy-side firms would be caught in the final phase of implementation – the so-called initial margin “big bang” – when the aggregate average notional amount threshold is scheduled to plummet from $750 billion to just $8 billion.
Firms subject to the initial margin regime need only post or collect margin when their counterparty exposure exceeds a separate exchange threshold of $50 million.
Last month, a group of trade bodies, including Isda, asked global regulators to raise the threshold at which counterparties must comply with the final wave, which would permanently exempt 992 firms. BAML’s Kodama called for regulators to make a swift decision.
“We need to have [clarity] very soon,” he said. “All the work we have to do is going to take a lot of time. It will be very hard for the industry to respond to any relief we get if that’s announced in 2020 [by regulators]. Even if that relief is [in] January 2020, it’s just too late.”
Another major worry concerns the operational task of getting ready for the rules. Kodama said it took the largest firms roughly two years to set up the correct infrastructure to comply, so with just two years to go, end-users are not currently paying enough attention to this impending issue. He also predicted that this implementation would be more complicated than the variation margin deadline in 2017.
“Awareness of the effort required by many buy-side firms is not where it needs to be. I think some of them will wait until 2020, while more sophisticated firms are working on setting up their infrastructure now. Some firms are waiting for a silver bullet, such as a vendor coming along and magically doing all of this for them,” he said.