Basel Committee Seeks Comment on Margining Practices Paper

Following analysis on margin calls during the market upheaval of March and April 2020, three regulatory authorities have published a report, Review of Margining Practices and are seeking industry feedback.

The BIS’ Basel Committee on Banking Supervision (BCBS), and Committee for Payments and Market Infrastructures, along with IOSCO say they are seeking comments on the consultative report as well as on potential further policy work, noting there was a “broad and rapid” increase in margin calls when the pandemic hit in what they describe as a “real-world test of derivatives and securities markets’ operations”.

The report – which is part of the Financial Stability Board’s work programme to enhance the resilience of the non-bank financial intermediation sector – looks at margin calls in March and April 2020, margin practice transparency, predictability and volatility across various jurisdictions and markets, as well as market participants’ liquidity management preparedness.

The three bodies say that based upon surveys of central counterparties, clearing members and broker-dealers, clients (i.e. entities that participate in these markets through an intermediary) and regulatory authorities, and other data analysis, the report finds that variation margin (VM) calls in both centrally and non-centrally cleared markets in March were large, and significantly higher than in February 2020. The peak CCP variation margin call was $140 billion on 9 March 2020.

The WM flows were a direct result, the report says, of significant shifts in market volatility during the period (VM flows are directly determined by the realised mark-to-market changes in portfolios). Furthermore, while centrally cleared VM calls were predominantly made on an end-of-day basis, there were significant intraday VM calls during the most stressful period in March. Most of these were made on pre- defined schedules, with some notable ad hoc calls on peak days.

Equally IM requirements for centrally cleared markets increased by roughly $300 billion over March 2020, and varied substantially across, and within asset classes, while, the same requirements on non-centrally cleared derivatives remained relatively stable during the stress period. The report says market volatility and model reactions to volatility were responsible for the majority of the peak increase in IM requirements, with changes in volumes and risk positions playing a smaller role – particularly for OTC interest rate swaps and exchange traded derivatives, which comprise the largest proportion of overall IM.

There was significant dispersion in the size of IM increases across, and within, asset classes. Price volatility and the reaction of CCP margin models to this volatility appear to have driven much of this dispersion, with the largest IM changes in markets that saw the largest volatility spikes, the report says. In addition to this, remaining differences may have been due to differing CCP model implementation, product features or portfolio composition. In particular, there is a diversity of model choices across CCPs and asset classes, with individual CCPs’ choices leading to differing reactions to underlying market volatility.

The report says that the stability seen in non-centrally-cleared IM is likely the result of the conservative design of the Standard IM Model (SIMM), though it also acknowledges it may be that IM requirements on non-centrally cleared transactions may be less reactive to increases in market volatility and provides perhaps a useful counterfactual to the experience in centrally cleared markets given the similar levels of volatility faced in key underlying markets.

The report observes that most CCPs provide tools to allow ‘what if?’ calculations of margin requirements, and while these were considered “useful”, it says some clearing members and clients suggested a range of potential improvements related to transparency, disclosure and functionality of these tools that would help them overcome the challenges of anticipating margin changes.

In general, intermediaries indicated they were relatively unaffected by changes in margin, and made few, if any, changes to counterparty margin call policies and procedures. Some indicated that they did make material changes to credit limits applied to counterparty positions or the credit limits imposed on those positions. More than half of surveyed clients reported no significant increases in liquidity demand from margin for both cleared and non-centrally cleared derivatives, although some faced liquidity needs materially greater than anticipated. Clients also varied in their level of preparedness for margin calls.

Fire selling of assets by clients was generally avoided, partly due to the intervention of central banks to support funding markets. Cash was key in funding the increased liquidity demand for the majority of clients surveyed; cash collateral posted to CCPs increased on both a relative and absolute basis during March, however, clients also increasingly used repo and asset sales to meet direct margin payments during the same period. While most clients stated that their intermediaries fulfilled their contractual obligations, some noted that margin unpredictability did increase during periods of peak market stress.

On the back of the analysis, the consultative report identifies six potential areas for further policy work. They are:

• Increasing transparency in centrally cleared markets.
• Enhancing liquidity preparedness of market participants as well as liquidity disclosures.
• Identifying data gaps in regulatory reporting.
• Streamlining variation margin processes in centrally and non-centrally cleared markets.
• Evaluating the responsiveness of centrally cleared initial margin models to market stresses, with a focus on impacts and implications for CCP resources and the wider financial system.
• Evaluating the responsiveness of non-centrally cleared initial margin models to market stresses.

Feedback is open until 12 January 2022.