Leaked doc: EU bans initial margin haircuts to resolve CCPs

Council will ban resolution authorities from dipping into clearing members’ initial margin

No haircuts

Leaked documents seen by Risk.net reveal European Union legislators will forbid resolution authorities from being able to raid clearing members’ initial margin accounts if a central counterparty (CCP) runs into financial trouble. Banks have long complained the tool would incentivise a dash for the exit as soon as clearers see signs of stress at a clearing house, to reduce their potential exposure to initial margin haircutting.

“[Initial margin haircutting] would incentivise runs on a CCP,” says Michael Voisin, a partner and global practice head for capital markets at law firm Linklaters. “The feeling is that if people sense that their initial margin is at risk, they will start closing out their positions rapidly at times of increased risk so as to create a return obligation for the excess initial margin, and so reduce liquidity in the market.”

On June 23, the Council of the EU, European Parliament and European Commission reached a political agreement on procedures for resolving a CCP in crisis, known as the CCP recovery and resolution regulation.

A controversial topic surrounding the framework has been whether resolution authorities should be allowed to apply haircuts on initial margin contributions that clearing members and end-users commit. Going into trilogue negotiations, the Council and Parliament had taken opposing stances on the matter.

The Council wanted to ban the tool. The parliament, however, proposed that resolution authorities should have all possible tools on the table. Proponents of initial margin haircutting say resolution authorities need as many resources as possible to cover shortfalls in cash at ailing CCPs quickly.

Documents seen by Risk.net, however, reveal the Council has held firm on the tool’s use and the final text will bar resolution authorities from being able to write down or haircut clearing members’ initial margin.

“The list of resolution tools will be closed, as proposed by the Council,” states a note written by the Croatian presidency of the Council on June 23. “This will also mean that IMH and IM write down will not be used in resolution.”

A separate leaked document created on June 30 sets out all three legislatures’ proposals before the trilogues and the final compromise text in four separate columns.

[Initial margin haircutting] would incentivise runs on a CCP
Michael Voisin, Linklaters

The column showing the final compromise mirrors the Council’s text on the treatment of initial margin in resolution.

First, it strikes out the provision within the Commission and Parliament’s proposals that state resolution authorities can use “any other resolution tool” that meets the objectives of resolution and adheres to a series of defined principles. That means authorities can only use the tools specified in the legislation.

The final compromise also adds initial margin to a list of liabilities resolution authorities are explicitly not allowed to write down.

Race to the exit

Clearing members are relieved at the exclusion of both IM haircutting and a tool known as forced allocation, which would allocate contracts from a member in default to a member not in default on a mandatory basis.

“The closed list of resolution tools doesn’t include initial margin haircutting or the writedown of initial margin, and there’s also no forced loss allocation,” says Ulrich Karl, head of clearing services at the International Swaps and Derivatives Association. “This means all the tools that are very procyclical and provide very unhelpful incentives for participants to stay with the CCP and support the default management process are out now. So that is a positive outcome.”

Karl adds that forced allocation could have a negative impact on clearing members, because the resolution authority may allocate positions to members who don’t have expertise in managing those specific contracts. Some clearing members may only focus on certain derivatives instruments, or indeed may avoid clearing exposures they consider too risky.

Karl Ulrich
Ulrich Karl

“Forced allocation is likely unequitable, as it becomes a question of who the resolution authority thinks this position should get allocated to and so who gets the hit,” says Karl. “This can provide wrong incentives, as these positions could also be allocated to a member that was prudently not trading the positions.”

The threat of initial margin haircutting had clearing members fearing there would be a rush to the exit during a stress event, as clearers close their positions to reduce the amount of initial margin that could be exposed to losses. This could have a second order effect that puts the CCP in deeper trouble as it effectively experiences a run on margin.

Linklaters’ Voisin says a dash for the exits also disincentivises clearing members from bidding for a defaulting member’s positions. Auctions occur in the earlier stages of a CCP’s processes for managing member defaults, with other members invited to purchase the defaulter’s positions. The advantage for members is that if suitable buyers are found for the defaulter’s portfolio, the CCP is less likely to use other members’ default fund contributions.

If clearing members choose to cut exposure to the CCP during a stress event, notes Voisin, that could mean they also have less incentive for participating in auctions, because the risks posed to each member if the auction fails will become smaller.

Philosophical implications

Nathaniel Lalone, a partner at law firm Katten Muchin Rosenman, says if resolution authorities had the powers to dip into IM, it fundamentally changes the nature of this collateral.

Initial margin is posted by clearing members and end-users to partly cover payments they need to make to counterparties in the event of their own default. 

“Superficially, going after initial margin may seem like a very tempting solution for resolution authorities, but the basic legal construct of clearing is that initial margin supports the clearing member’s own portfolio and is not exposed to the losses of other clearing members,” says Lalone. “Haircutting initial margin would seriously weaken this principle of bankruptcy-remoteness and would be not just a material, but a fundamental, change in the legal construct of how clearing works.”

Kay Swinburne, formerly a member of the European Parliament and now vice-president of financial services at consultancy KPMG, agrees IM should not be viewed as a pot of money to prop up a CCP. She had argued in favour of banning initial margin haircutting while she was a co-rapporteur responsible for steering the CCP recovery and resolution regulation through the parliament before the European elections in May 2019.

“It’s not a loose pool of money. It belongs to investors [end-users] who effectively have committed that margin,” she says.

Capital gains

The bankruptcy-remote status mentioned by Lalone is important for banks who are either clearing members or end-users, because it means they avoid having to calculate a counterparty credit risk capital charge on their posted initial margin.

The Basel Committee on Banking Supervision’s standards on capital requirements for bank exposures to central counterparties allow banks to assign zero counterparty risk to their margin if it is bankruptcy-remote. This treatment is included in current rules, and in the forthcoming Basel standards that member jurisdictions are meant to implement by January 2022.

The same provision is held within the EU bank capital laws, known as the Capital Requirements Regulation.

But not all forms of initial margin are bankruptcy-remote. If resolution authorities fail to recapitalise or resolve a CCP and it goes into bankruptcy proceedings, collateral posted as cash is still fair game for the courts to use to cover losses.

“A lot of initial margin is given by way of securities and is insolvency-remote and therefore has a very favourable risk weighting attached to it because it’s not treated as creating exposure to a CCP,” says Linklaters’ Voisin. “Whereas if it could be haircut, then it would need to carry a greater risk weighting and that would have negative regulatory capital implications for the banks.”

In a funny sort of way initial margin haircutting is actually the default setting once everything else has failed
Simon Gleeson, Clifford Chance

Generally, securities posted as collateral are bankruptcy-remote because they are held by a third-party custodian. Cash collateral, however, is held by the CCP and invested by it into securities, which is why it can be tapped by a bankruptcy court as part of the general insolvency estate.

“One of the consequences of insolvency is precisely initial margin haircutting for anybody who put up cash margin, because in an insolvency all senior creditors are treated pari passu,” says Simon Gleeson, a partner at law firm Clifford Chance. “Initial margin creditors are no different from any other sort of creditor, so in a funny sort of way initial margin haircutting is actually the default setting once everything else has failed.”

This is why the majority of collateral posted is in the form of securities. Analysis by Risk Quantum found the most popular form of collateral posted at the largest 10 CCPs were sovereign bonds, which made up 48% of initial margin held by those CCPs on average at the end of September 2019.



If the CCP recovery and resolution regulation works as intended, no CCP should ever get to the point of being insolvent, as resolution authorities try to do everything they can to avoid that scenario.

Editing by Philip Alexander

  • LinkedIn  
  • Save this article
  • Print this page  

Only users who have a paid subscription or are part of a corporate subscription are able to print or copy content.

To access these options, along with all other subscription benefits, please contact [email protected] or view our subscription options here: http://subscriptions.risk.net/subscribe

You are currently unable to copy this content. Please contact [email protected] to find out more.

You need to sign in to use this feature. If you don’t have a Risk.net account, please register for a trial.

Sign in
You are currently on corporate access.

To use this feature you will need an individual account. If you have one already please sign in.

Sign in.

Alternatively you can request an individual account here: