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With only six months to go to Phase 6 (Sept 2022), the lead time to completion and the scale of efforts should not be underestimated.
In brief
- Initial Margin requirements will apply to a large number of Phase 6 counterparties starting in September 2022.
- Market participants will need to consider applicability, monitoring and implementation activities early to ensure compliance.
- Implementation efforts should not be underestimated as they are more significant compared to variation margin from an operational and documentation perspective.
The Swiss Financial Market infrastructure Act (FMIA) requires financial counterparties and large non-financial counterparties (as defined in FMIA) with a volume of non-centrally cleared derivatives (AANA) above certain phase-in thresholds to exchange bilateral initial margin (IM) from the respective compliance date.
The six implementation phases follow the Basel Committee on Banking Supervision (BCBS) and International Organization of Securities Commissions (IOSCO) timetable:
Many financial market participants with AANAs between CHF 8bn and 50bn are expected to trigger the requirements in phase 6 (Sept 2022). All others with AANAs under CHF 8bn are not required to comply as long as they do not exceed the AANA threshold.
AANA calculation
The AANA calculation refers to the aggregate average notional amount of uncleared OTC derivatives based on the month-end amounts of March, April and May of each year. The applicability of the compliance date (e.g. September 2022) depends on the AANA calculation based on March, April and May of the same year (e.g. 2022). This is done on a consolidated group (not single entity) level.
It should be noted that the AANA calculation is somewhat different from the FMIA classification threshold calculation which is based on the gross notional amount of OTC derivatives calculated on a rolling 30-day average excluding FX swaps and forwards settled payment versus payment. Therefore, while IM requirements would typically apply to “large” counterparties, they could also apply to counterparties classified as “small” under FMIA in some cases.
Reduction limits
According to FMIA, counterparties may reduce IM (determined at group level) by no more than: (i) CHF 50m if both parties are parts of different groups, and (ii) CHF 10m if both parties belong to the same group. In other words, the IM amount will not need to be exchanged below the agreed reduction limit (e.g. up to CHF 10/50m).
FINMA has further explained in its Guidance 01/2020 that it will follow the BCBS/IOSCO guidance whereby documentation, custodial and operational implementations are not required if the reduction limit is not surpassed. However, FINMA expects that in-scope entities will act diligently as the reduction limit approaches.
New transactions
IM must only be exchanged for new transactions entered into after the compliance date of the relevant year (e.g., 1 Sept 2022). Therefore, the amount of IM to be exchanged is expected to gradually increase towards the reduction threshold (e.g. CHF 10/50m) so that the first exchange is required within the weeks/months after the compliance date.
As a result, counterparties may fall into phase 6 for the applicability of the IM requirements but it may take time before they have to actually exchange IM. ISDA estimates that between 78% and 85% of phase 6 counterparty relationships are unlikely to breach the reduction limit, depending on the calculation methodology used1. Regardless, it is important to continuously monitor exposures to ensure the reduction limit is not exceeded prior to the full implementation with counterparties and custodians. Therefore, the first priority would be the establishment of policies and operational procedures for an IM calculation and monitoring framework.
Note: FINMA Guidance 02/2021 explains that amendments to existing derivative contracts solely to address the IBOR transition would not trigger margin obligations with respect to the amended trades (i.e. they are not “new trades” for IM compliance purposes).
Notification of counterparties
In order for the negotiation of IM documentation and custodial onboarding to commence, it is essential that any group that either knows or expects that it will breach the phase 6 threshold notify its counterparties and chosen custodian as soon as possible. Without this notification and subsequent planning, there is a risk that the relevant relationships will not be able to complete all the steps necessary to exchange IM by the time it is required.
Notification can be conducted via any means preferred by the disclosing group, but to assist with this effort ISDA offers the following methods by which market participants can self-disclose to their counterparties:
- Electronically deliver the ISDA IM Self-Disclosure Letter to other ISDA Amend participants via the ISDA Amend platform.
- Provide the ISDA IM Self-Disclosure Letter to counterparties directly.
- Participate in ISDA’s multi-lateral IM self-disclosure exercise; information will be shared exclusively with other contributing entities from all IM phases.
The number of counterparties caught by Phase 6 is expected to be double that of Phase 5 – estimated at more than 750 entities, equating to more than 5,000 relationships – leading to concerns about bottlenecks and delays in the lead up to the September 2022 deadline
Importance of threshold monitoring
The number of phase 6 institutions is expected to be significantly higher than those in phase 5 (estimated at 775 entities 1) and additional firms are expected to come into scope of IM requirements every year. Further, there are many elements involved in the implementation of IM, which is very different from variation margin from an operational and documentation perspective. Therefore, institutions are encouraged to assess their applicable compliance dates early and begin monitoring and implementation activities as soon as possible and well ahead of the IM threshold calculation period (March – May). Typically, based on our experience for previous IM phases, the preparations start as early as one year prior to the foreseen compliance date. Therefore, an anticipatory IM threshold monitoring is key. This will be on ongoing industry effort up to and well beyond September 2022.
Summary
With the Phase 6 compliance date for Initial Margin requirements quickly approaching (Sept 2022), market participants will need to assess applicability of the rules to leave sufficient time for implementation, if necessary. Even where the actual exchange of Initial Margin is not required from the start, they will nevertheless need to establish an appropriate reduction threshold monitoring framework for 2022 and beyond.
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