Margin requirements for bilateral OTC derivatives will drive collateral demand, officials say

By July 1, 2015Industry Updates

Jun 29 2015 Patricia Lee, Regulatory Intelligence

Demand for collateral is expected to increase following the introduction of initial margin requirements for non-centrally cleared over-the-counter derivatives trades, and this will in turn have implications for the international economy, sources said.

The new margin requirements recommended by the Basel Committee on Banking Supervision and the International Organisation of Securities Commissions are likely to present considerable challenges for financial institutions.

Tom Jenkins, partner at KPMG China, said market participants would increasingly find their collateral management process under pressure once the margin requirements are implemented.

“This is because under these regulations they will have to calculate the amount of margin required and post this margin to their counterparty within a very short time frame,” he said.

Initial margin

Sam Ahmed, managing director at DerivAsia in Singapore, said the mandatory introduction of initial margin for bilateral derivatives trades from September 1, 2016 onwards has emerged as the single most important concern for market participants because initial margin is a Value at Risk- (VaR) based calculation methodology and is being introduced for the first time as a mandatory regulation in the bilateral OTC markets. Variation margin, on the other hand, uses mark-to-market calculation.

“This makes the amount of initial margin which market participants have to post for bilateral trades significantly higher. In addition, given that rehypothecation will not be allowed, the initial margin received from a counterparty has to be locked away in segregated accounts indefinitely which may be detrimental to the supply of high quality liquid assets in the economy,” he said.

Market participants are concerned about the implications of having to post initial margin for non-centrally cleared derivatives trades. They would need a lot more collateral to keep trading the same amount of derivatives that they have been trading. The implication on the economy is a potential shortfall in the amount of eligible collateral, they said.

Variation margin

Ahmed said the requirement to post variation margin for bilateral derivatives trades presents a second challenge to market participants. Under the BCBS/IOSCO recommendations, collateral posted as variation margin must be consistent with the currency of the underlying instrument. This recommendation, according to Ahmed, has raised concerns among market participants because the market could potentially be “squeezed” if there is a financial crisis in one jurisdiction.

“Today if an Australian bank is trading with a Hong Kong bank in Hong Kong underlying swaps and the Hong Kong bank is given a margin call, it can deliver the margin call in any eligible collateral that is agreed bilaterally. This could be Singapore dollar bonds or Australian dollar government bonds. However, under the new proposed margin rules, the currency of the underlying trade and collateral must be consistent,” he said.

Using the same example, Ahmed said if there is a crisis in Hong Kong, the Hong Kong bank receiving the margin call will be forced to source Hong Kong dollar collateral even under stressed local market conditions where liquidity may have dried up totally.

Removal of threshold

BCBS/IOSCO’s recommendations to remove the thresholds for margin call under the guidelines on margin requirements for non-centrally cleared derivatives trades has emerged as a further challenge to market participants. According to Ahmed, under current practice, market participants put threshold amounts in their collateral agreement below which, there would not be a need to post any margin. But BCBS/IOSCO has recommended the removal of such thresholds.

“BCBS/IOSCO rules are calling for no threshold collateral agreements. This means that even if there is a small margin call, BCBS/IOSCO want to ensure that market participants adopt best practices and exchange collateral to account for the credit risk arising from the negative mark-to-market even if the amount is minimal,” he said.

Ahmed said while BCBS/IOSCO realised that this may be operationally demanding, they wanted to ensure that counterparties put in place adequate risk mitigation measures.


  • Patricia Leeis South-East Asia editor at Thomson Reuters Regulatory Intelligence in Singapore. She also has responsibility for covering wider G20 regulatory policy initiatives as they affect Asia. 

This story first appeared on Thomson Reuters Accelus Regulatory Intelligence.

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