Initial margin: the final act

Practice makes perfect, the saying goes. When it comes to the final wave of implementation for uncleared margin rules, however, this may not hold true.

On September 1 of this year – six years after the first batch of dealers were forced to post initial margin (IM) on bilateral swaps – the sixth and final cohort will be swept into the global regime.

The compliance process has been tried, tested and improved upon over the years – yet this final hurdle represents a challenge like no other. The estimated 775 firms set to breach the threshold – €8 billion average aggregate notional amount (AANA) of bilateral swaps – is more than the previous five phases combined. The cohort breaks down to a whopping 5,400 counterparty relationships, according to the International Swaps and Derivatives Association (Isda).

Even accounting for exchange threshold relief, which permits those with IM exchange amounts below €50 million to trade without documents, Isda believes at least 1,000 relationships require repapering and custody account setups. Some fear a repeat of the bottlenecks that plagued the first phase and cast a shadow over phase five.

“A bottleneck continues to be the biggest enemy for phase six, especially when you look at custodians,” says one lawyer working with phase six clients on IM implementation.

It’s not just the numbers. While the buy side dominated the 300 or so firms caught in phase five, a drop in the AANA threshold from €50 billion to just €8 billion spreads the requirements across a far broader assemblage of derivatives users. This includes funds subject to other regulatory frameworks, such as Ucits funds. One investment manager warns of an “existential clash” between consumer protection rules aimed at fostering liquidity and those intended to eliminate systemic risk.

Many firms coming into scope have limited access to the most commonly used collateral – highly rated government bonds. Some may choose to post eligible equities, others may balk at the 50% haircut. For the first time under IM rules, cash collateral looks set to play a larger role. Here, firms face cross-border tangles. US rules require cash IM to be reinvested in cash-like instruments such as money market funds. European rules permit only Ucits-eligible money-market funds – yet these are few and far between.

The rules will be put to the test for managed accounts, which see large funds allocate parts of the portfolio across different investment managers. Where these funds rely on the exchange threshold monitoring, a close eye is required to avoid individual managers inadvertently breaching the group threshold.

There’s another big difference this time around. Implementation is taking place against a backdrop of soaring inflation, rising interest rates and heightened geopolitical tension. Market disruption and heightened volatility is bad news for implementation projects. It’s also bad news for firms relying on threshold monitoring, as modest market moves can have an outsize impact on options-heavy exposures.

Those hoping for a further reprieve in the roll-out of the regime will likely be disappointed. While the Covid‑19 pandemic delayed the final two waves by a year, participants say phase six is too far down the road to be postponed again.

“It’s too late in the day,” says the lawyer working with phase six clients. “Never say never, but we’ve already had delays, and I can’t see any chance of this being delayed further.”