Enter to open, tab to navigate, enter to select
ISDA® Releases Reg-Compliant Margin Model for Uncleared Swaps; New CSA in the Works
Practical Law Legal Update 1-600-1026 (Approx. 6 pages)
ISDA® Releases Reg-Compliant Margin Model for Uncleared Swaps; New CSA in the Works
by Practical Law Finance
| Published on 24 Feb 2015 • USA (National/Federal) |
ISDA has finalized its standardized initial margin model (SIMM) to calculate initial margin (IM) for uncleared OTC derivatives. The SIMM is designed to facilitate compliance with uncleared swaps margin rules in multiple jurisdictions and would affect new and existing CSAs for parties following the model. ISDA is also developing new CSAs to accommodate the SIMM.
On February 11, 2015, ISDA® held a webcast outlining its new standardized initial margin model (SIMM™) for calculating initial margin (IM) in connection with uncleared over-the-counter (OTC) derivatives. The SIMM is designed to permit market participants to comply with uncleared-swaps margin rules in the US, the EU and Japan. While exact margin thresholds differ among these jurisdictions, the phase-in periods are the same, beginning in December 2015.
ISDA announced that, in connection with this:
- It is creating a new suite of ISDA Credit Support Annexes (CSAs) and credit support deeds under New York law, English law and Japanese law.
- It will release a protocol to assist market participants with amending their existing CSAs to reflect the SIMM and new rules in these jurisdictions.
The SIMM, which is not mandatory, sets parameters for the negotiation of the CSA that comply with margin rules in these jurisdictions. Parties that elect to use the SIMM will likely need to amend their existing CSAs to modify the following terms:
- Collateral eligibility (the types of collateral that may be delivered may vary among jurisdictions).
- Collateral haircuts.
- Calculation and collection timing (when collateral must be delivered, and how that applies to certain forms of collateral).
- Dispute resolution (whether the dispute resolution provision in the current CSA needs to be updated).
- IM mechanics - which must be consistent with applicable segregation requirements.
ISDA's Legal and Documentation Working Group is currently drafting new CSA templates to address these documentation needs created by the SIMM.
According to the webcast, there will be two stages to implementation of the SIMM:
- In stage one, ISDA will release a protocol that will enable market participants to update variation margin (VM) CSA terms so that they are compliant with VM requirements scheduled begin phase-in December 1, 2015 (see Practice Note, US Derivatives Regulation: Margin Collection and Exchange Requirements for Uncleared Swaps and CFTC Re-proposes Corollary Dodd-Frank Margin Rules for Uncleared Swaps). (Unlike IM under proposed rules, VM does not require a complex calculation, as it is typically equal to 100% of counterparty exposure under the transaction.)
- In stage two (between December 2015 and December 2019), parties using the SIMM will enter into a new template CSA to be published by ISDA, consistent with the SIMM, which will cover transactions subject to IM and VM regulatory requirements. Contractual architectures have been proposed for this new CSA that would permit parties that would like to preserve existing pre-phase-in IM arrangements to do so. (As currently proposed, the margin rules in these jurisdictions would only apply to swaps entered into after the applicable phase-in date.)
The SIMM, originally proposed in late 2013 (see Legal Update, ISDA Proposes Standard Initial Margin Model for Uncleared Derivatives), is timely, as CFTC Chairman Timothy Massad announced the agency's intention to support globally coordinated swap margin rules, even though the CFTC and US bank regulators have proposed margin requirements for uncleared swaps that are scheduled to begin to become effective in late 2015 (see Practice Note, US Derivatives Regulation: Margin Collection and Exchange Requirements for Uncleared Swaps and CFTC Re-proposes Corollary Dodd-Frank Margin Rules for Uncleared Swaps). However, these rules are still in the proposal stage in the US and could be further tweaked to align with the rules of other jurisdictions. If so, it is unclear if the SIMM may also require further tweaking once the rules are finalized.
The ISDA webinar sets out the following steps for determining which jurisdiction's rules apply:
- Conduct an analysis of each counterparty relationship to determine which, if any, jurisdiction's margin rules apply. The analysis may be required to be conducted with respect to the margin rules of multiple regulators. (For information on the application of US rules, (see Practice Note, US Derivatives Regulation: Cross-Border Application of Swaps Rules).
- Determine the scope of application of that jurisdiction's rules, which may:
- require that a party post or collect VM only;
- require that a party post or collect both VM and IM; or
- not apply.
In order to determine which, if any, of the jurisdictions' margin regulations apply to a particular counterparty relationship, a market participant will likely need to know:
- Its status (and its counterparty's status) under each of the market regulations (i.e., whether it is a swap dealer (SD) or financial end user, for example).
- Its average aggregate notional amount (AANA) (and its counterparty's AANA) under each applicable regulation.
- Relationship-specific information, such as whether it has received a guarantee from its counterparty and where that guarantor is domiciled.
ISDA notes that regulators have not yet provided details on how these rules will apply in the cross-border context.
The SIMM methodology is based on the "Sensitivity Based Approach" (SBA) outlined by the BCBS in July 2014, which seeks to provide common ground for firms in assessing risk in their books (see BCBS, Instructions for Basel III Monitoring) and is based on dividing uncleared swaps into four asset classes:
- Rates/foreign exchange (FX).
- Credit, which includes:
- single-name and index credit default swaps (CDS); and
- structured credit products, including asset-backed and mortgage exposure.
- Equities.
- Commodities.
Risk is aggregated separately in each of these four asset classes. The SIMM model then provides pre-defined inputs into the SIMM model. The inputs may include factors such as:
- Sensitivities on certain risk factors available to use in the SIMM (such as DV01 at ten year tenor). For instance, if the DV01 at the ten year point on an interest rate swap is 9,000 and the risk weight is 40, the product of the two numbers (360,000) is an important component of the risk-based calculation.
- Application of risk weights and correlation to those risk-factor sensitivities. These can be taken account by using a correlation table.
- Aggregation of risk to recognize hedging and diversification within an asset class.
According to the webinar:
- CSAs and other collateral documentation will need to be modified or replaced, as discussed above. ISDA plans to create a new suite of CSAs and credit support deeds under New York law, English law, and Japanese law to reflect the SIMM.
- Custodial arrangements will need to be established to segregate IM in accordance with the SIMM and applicable rules.
- New or updated opinions may be necessary for market participants in certain jurisdictions.
- New ISDA Master Agreements may be necessary in the US.
In the near-term, ISDA recommends that the documents of the following parties be addressed:
- Counterparties for whom VM requirements are applicable in 2015, but not IM requirements. This group is further divided into counterparties who:
- currently post (or will post) non-regulatory (pre-phase-in) IM; and
- do not currently post (and will not post) non-regulatory (pre-phase-in) IM.
- Counterparties for whom VM and IM requirements are applicable in 2015.
ISDA created the SIMM model to:
- Reduce the amount of IM that will be required to be posted in connection with uncleared swaps.
ISDA's SIMM requires lower IM collection in connection with uncleared OTC derivatives than is required under the 2013 BCBS/IOSCO proposal (see Legal Update, Final Global Margin Rules for Uncleared Derivatives Released by International Regulators). In 2014, US, European and Japanese regulators set four year phase-in periods for the BCBS/IOSCO framework, beginning in December 2015 with the largest, most active and most systemically important derivatives market participants.
According to the ISDA webinar, VM rules will be applicable to the vast majority of OTC derivatives counterparties in 2015, while IM rules will only apply to a small group in 2015 and will be rolled out through 2019. (Most uncleared-swap counterparties already collect mark-to-market VM from their counterparties on a daily or intra-day basis.)
"ISDA" and "ISDA SIMM" are registered trademarks of the International Swaps and Derivatives Association, Inc. (ISDA). ISDA is not a sponsor of Practical Law and had no part in the development of this resource.