Margin requirements for non-centrally cleared swaps will increase risk and have a “harmful impact” on markets and the financial system as a whole, according to a study by the International Swaps and Derivatives Association (ISDA).
On Tuesday the trade association published an analysis of initial margin (IM) requirements for non-centrally cleared OTC derivatives under current regulatory proposals. Among its other findings was that the level of IM required under current proposals is very high, ranging from $1.7 trillion to $10.2 trillion; also, the increased amount of IM that would be required in stressed conditions “will result in greatly increased demand for new funds at the worst possible time for market participants,” ISDA said.
While corporates got confirmation of their end-user exception to Dodd-Frank’s central clearing and trade execution mandate earlier in November, margin is still a big issue for corporations. The Commodity Futures Trading Commission (CFTC) has said that final margin requirements for uncleared swaps would be issued in January. But as of now the lack of guidance on margin and capital is hampering dealers’ attempts to set expectations for their clients and counterparties on terms, availability and pricing.
In separate letter to regulators, ISDA said that as proposed, the IM requirement will:
“[S]everely challenge the resiliency of the financial system and will severely curtail the use of uncleared swaps for hedging, which would disrupt key financial services, such as those that provide for wider availability of home loans and domestic and international corporate finance.”
Instead of the IM requirement, ISDA said systemic risk can be better mitigated with its proposed “three-pillar framework,” which imposes variation margin (VM) requirements “with daily collection and zero thresholds; implement appropriate capital requirements, and third, require clearing of liquid standardized swaps.”
In a statement, Robert Pickel, ISDA chief executive officer, said it was ironic that the margin rules that have been currently proposed would increase systemic risk. “They could very well harm the financial system they are designed to protect,” he said.
ISDA said its IM analysis is based upon data submitted by member firms to the Basel Committee on Banking Supervision (BCBS) and the International Organization of Securities Commissions (IOSCO) joint Working Group on Margining Requirements (WGMR), as part of the WGMR’s Quantitative Impact Study (QIS).