The Financial Stability Oversight Council says there are proposals to address worries that collateral scarcity will result in new financial regulation. In its annual report, the FSOC says there have been suggestions that regulators widen the category of assets that qualify for collateral.
“In response to potential collateral scarcity [concerns], various initiatives have emerged,” the FSOC said in its annual report. “For example, many have suggested that regulators broaden the types of assets that qualify as eligible collateral (subject to appropriate haircuts) to assist market participants in collateralization alternatives. In the case of non-centrally cleared OTC derivatives margin, 80 percent is posted in cash according to the International Swaps and Derivatives Association’s (ISDA) margin survey.”
US financial industry groups have been lobbying hard to get regulators to abandon initial margin. ISDA has been particularly vocal. Late last year the group wrote a letter the International Organization of Securities Commissions (IOSCO) and the Basel Committee on Banking Supervision (BCBS) saying that while they support proposals for a “robust Variation Margin (VM) framework,” it believes the initial margin (IM) component of the WGMR [Working Group on Margining Requirements] proposals will severely impact liquidity in the vital uncleared OTC derivative markets, and could increase rather than decrease systemic risk. Phasing-in of rules will not alter this outcome.”
The FSOC does acknowledge that margin requirements do have the potential to exacerbate volatility during times of distress. “[M]argins and collateral haircuts increase when market volatility rises,” the FSOC wrote. “As a result, demand for eligible collateral could jump significantly in response to market stress, forcing market participants to exit positions quickly if they do not have continued access to eligible collateral, which exacerbates volatility.” However, it uses this to bolster its argument for IM: “Initial margins fixed at the trade date can also help to mitigate procyclicality” of margin requirements.
Furthermore, the FSOC says that non-cash eligible collateral is estimated to be about $74 trillion vs. collateral needs that are smaller and incremental; also, collateral reforms – i.e., mandatory clearing of certain derivatives, margin requirements for many non-centrally cleared derivatives, restrictions on the ability to re-hypothecate collateral, and the Basel III liquidity standards – will be phased in over an extended time period. Therefore, the FSOC, writes, there is “no immediate collateral cliff overshadowing the market.”
Currently IOSCO and the BCBS are studying the comments it has received on its Second Consultative Document the groups released in February. The comment period ended March 15, 2013 although that hasn’t stopped ISDA and others from continuing their lobbying campaign (see related story here).