Capco Blog

Bilateral margin requirements: a liquidity vortex?

OTC Clearing Part 8

$30,000,000,000,000 - This huge figure is the estimated additional liquidity financial institutions worldwide will need if the current proposal by the International Organisation of Securities Commissions (IOSCO) and the Basel Committee on Banking Supervision (BCBS) on margin requirements for non-centrally-cleared derivatives were to be implemented.

The estimate was calculated by the International Swaps and Derivatives Association (ISDA) for covering the requirement for a universal two-way exchange of initial margin (IM) between financial firms and systemically important non-financial firms. The ISDA provided some telling examples to put this number in context:

  • The quantitative easing (QE) exercises conducted by the large central banks have ranged between $0.5 and $1 trillion
  • The capital of the largest 16 banks in the global banking system is around $1 trillion

In addition, the yearly gross domestic product of the EU and US combined is roughly $30 trillion.

On the back of the G20 commitment, both EMIR and Dodd-Frank mandate clear standards and rules on how to mitigate risk for derivative trades not cleared through a clearing house. In order to create a level playing field for the market globally, regulators tasked BCBS and IOSCO with this consultation exercise.

Posting initial margin is another nail in the coffin for the once cosy world of bilateral OTC trading. Increased core capital requirements, the cost of clearing and, at a later stage, heightened transparency through electronic trading will all lead to an erosion of profit margins. In addition, posting initial margin in the bilateral world is new to most market participants and thus would require investment to upgrade systems and educate staff, not to mention renegotiating thousands of bilateral master agreements.

One important question remains: where will the initial margin be held? The consultation paper maintains that it must be immediately available to the collecting party in case of the counterparty’s default being fully protected under local law. A third party like a custodian would fit this description but with only a small number of globally active custodians concentration risk becomes an issue. It also remains unclear whether core capital would need to be allocated to initial margin held with such a third party, which would add to the already high clearing tab.

Although a globally standardised approach to collateralisation is a worthy goal, the current proposal needs fine-tuning to ensure that no unnecessary burden is being placed on the market as a whole. Everyone is eagerly waiting for a final proposal from BCBS and IOSCO to see in which direction the bilateral risk mitigation train is heading.

Next week I’ll look at what will influence trading in OTC derivatives in the future.


I believe what matters is the notional amount of non-centrally-cleared derivatives. AS the margin requirements should be calculated on that basis, rather than the nominal amount of non-centrally-cleared derivatives.

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