In the coming months we expect to see the European Securities and Markets Authority (ESMA) issue further clarification on where a clearing obligation starts and what exactly needs to be centrally cleared. We also expect the Financial Stability Board (FSB) to issue recovery and resolution standards for Central Counterparties (CCPs) and provide confirmation of how the authorities intend to aggregate trade repository data.
Looking forward it is also important to take note of a working paper issued by the Bank of England in May 2014 which, in common with recent publications from the International Organisation of Securities Commissions (IOSCO), highlights the procyclicality of risk-based initial margin models. This paper highlights that margin requirements for the same portfolio are higher in times of market stress and lower in calm markets. The procyclicality can cause liquidity stress whereby parties posting margin have to find additional liquid assets, often at just the times when it is most difficult for them to do so. Therefore, regulators want margin models that are adequately risk sensitive but not ‘overly’ procyclical.
As there is currently no standard definition of procyclicality the paper proposes two types of quantitative measure of procyclicality: one that examines margin variation across the cycle and one that focuses on short-term margin increases. It then studies, using historical and simulated data, various margin models with regard to both their risk sensitivity and the proposed procyclicality measures. It finds that models which pass common risk sensitivity tests can have very different levels of procyclicality.
The paper further recommends that banks and major dealers disclose the procyclicality properties of their margin models, perhaps by reporting the proposed procyclicality measures. The objective would be to help derivatives users to anticipate potential margin calls and ensure they have adequate holdings of or access to liquid assets. In addition to bringing additional transparency to the differing margin models used by clearers, this could have a significant implication for collateral management in the future.
For more information, please visit the Bank of England website.
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