Derivatives markets brace for Basel III margin crunch in 2015

O’Malia: participants may struggle to meet the December 2015 deadline

Derivatives market participants are concerned about the impact of new margin requirements for non-cleared derivatives under Basel III, with a large number unsure whether they will even have to comply with the rules, according to new survey by the International Swaps and Derivatives Association.

Developed by the Basel III working group on margining in cooperation with IOSCO – the International Organisation of Securities Commissions – the new rules will require most derivatives users to post initial and variation margin on non-cleared derivatives transactions. But a third of respondents to the ISDA survey said they were unsure whether they would be subject to the rules. And of the 36% that knew they would have to comply, nearly two thirds (65%) said they were concerned or somewhat concerned about their ability to meet the requirements, which are due to take effect in December 2015.

The current proposals set a phase-in schedule for the posting of initial margin, starting with the largest derivatives users from December 2015 and extending through to December 2019. Variation margin posting is slated to begin for all eligible counterparties from December this year, requiring firms to make significant changes to systems, processes and documentation.

The Basel proposals still have to transposed into national law by national and regional regulators. Regulators from the US, Europe and Japan released proposed requirements in September, April and July last year, but final rules have not yet been published, although this is expected imminently. Nevertheless, the December deadline is expected to stand.

“The survey results indicate that many market participants may struggle to meet the December 2015 effective date, especially given that a large number of end-user firms still appear unsure whether the rules apply to them,” said Scott O’Malia, chief executive of ISDA. “Once the margin rules are finalised, it is vital that market participants have sufficient time to allow for the legal, operational and technological enhancements necessary to effectively and safely implement these new requirements. That’s why ISDA has recommended a longer, phased implementation schedule to accommodate the adoption of a transparent standard industry model and the necessary documentation to exchange collateral on a global basis. It is also important that there is consistency between the various sets of rules, particularly regarding which market participants must post and collect margin.”

The top three concerns flagged by respondents in the ISDA survey were the increased costs of hedging under the new rules (59%), regulatory uncertainty (38%) and concerns about the scope of cross-border derivatives regulation (36%). The last of these appears to be having a tangible effect on end users: 53% of respondents thought derivatives markets were fragmenting along geographic lines as a result of new regulation, with more than half of those (55%) claiming this is having a negative or strong negative impact on their ability to manage risk.

Of the 400 respondents who answered some or all of the survey questions, 24% work at non-financial corporates and 57% are employed by financial institutions (insurers, finance companies, asset managers and bank end users). 41% of respondents work for firms based in Europe, and 47% in North America.

Despite misgivings over the margin rules, derivatives remain important risk management tools for banks and their customers. In the survey, 81% of respondents said that derivatives are important or very important to their firm’s risk management strategy, while 78% expect their use of derivatives to increase or stay the same over the first three months of 2015. The firms use derivatives for a variety of risk management purposes, with managing exposures to currencies, interest rates, commodities and credit emerging as the most popular use (65%). Hedging exposures to international markets (52%) and reducing financing costs (38%) were also highly ranked.