This document presents the final policy framework establishing minimum standards for margin requirements for non-centrally cleared derivatives, agreed upon by the Basel Committee and IOSCO. This framework was developed in response to the 2007 financial crisis, which highlighted weaknesses in banks' resilience to economic shocks. Margin requirements aim to improve transparency and reduce systemic risk associated…
This document, entitled "Margin requirements for non-centrally cleared derivatives," was published in 2020 by the Basel Committee on Banking Supervision (BCBS) in collaboration with the International Organization of Securities Commissions (IOSCO). It is an international standard establishing a regulatory framework for margin requirements applicable to derivatives not cleared through central counterparties (non-centrally cleared derivatives). The scope covers OTC derivatives not cleared by CCPs, the systemic financial and non-financial entities concerned, as well as the calculation, coverage and management modalities of initial and variation margins. The document is based on consultations, quantitative impact studies (QIS) and analyses conducted since 2011, with final implementation scheduled for September 2021 (p. 1-27).
The document presents the final policy framework for margin requirements on derivatives not cleared through central counterparties, jointly developed by the BCBS and IOSCO. This framework addresses the need to mitigate systemic risks revealed by the 2007 financial crisis, notably related to non-standardized OTC derivatives not cleared by CCPs, which represent several hundred trillion dollars in notional amounts (p. 6-7). The main objective is to reduce systemic risk by ensuring the availability of collateral to cover losses in the event of a counterparty default, and to promote the use of central clearing by reflecting the higher risks of non-cleared derivatives. The framework mandates the mandatory bilateral exchange of initial and variation margin between all covered entities (systemic financial and non-financial), with a maximum threshold of EUR 50 million for initial margin and a minimum transfer threshold of EUR 500,000. Margins must be calculated according to rigorous methodologies, either by approved quantitative models or by a standardized schedule, ensuring 99% confidence coverage over a 10-day horizon including a stress period (p. 6-17). The framework also provides an expanded list of eligible collateral assets, with calibrated haircuts reflecting market, credit and liquidity risks, and emphasizes the legal and operational protection of exchanged initial margins, notably via segregation and strict conditions governing re-hypothecation (p. 20-25). Implementation is phased, with an activity threshold of EUR 8 billion notional for final application, and international coordination is required to avoid regulatory arbitrage and conflicting requirements in cross-border transactions (p. 8-9, 22-23). Finally, a monitoring group is established to assess effectiveness, liquidity impact and international consistency of the framework, with the possibility of future adjustments (p. 9-10).
The 2007 financial crisis highlighted the vulnerabilities of financial institutions to economic shocks, particularly in the area of OTC derivatives not cleared by CCPs, which present significant systemic risks due to their opacity and size. In response, the G20 launched in 2009 a reform program aimed at reducing these risks, including central clearing, increased transparency and strengthened margin requirements for non-cleared derivatives. The BCBS and IOSCO were mandated to develop consistent global standards on these margin requirements, with main objectives to reduce systemic risk, promote central clearing and limit financial contagion risks. The document aims to define a harmonized regulatory framework, applicable to systemic financial and non-financial entities, taking into account operational, legal constraints and liquidity impacts. Limitations include the exclusion of CCP-cleared derivatives, transactions with certain public entities and physically settled FX forwards and swaps (p. 6-13).
- Scope of instruments: Margin requirements apply to all derivatives not cleared by CCPs, except physically settled FX forwards and swaps, for which only variation margin is recommended (p. 11-12).
- Applicability to entities: Requirements concern all systemic financial and non-financial entities ("covered entities"). Non-systemic entities, central banks, sovereigns, multilateral development banks and the BIS are exempt. Bilateral exchange of initial and variation margin is mandatory, with a maximum threshold of EUR 50 million for initial margin and a minimum transfer threshold of EUR 500,000 (p. 13-15).
- Margin calculation methodologies: Variation margin covers current exposure and must be exchanged frequently (e.g., daily). Initial margin covers potential future exposure, calculated with a unilateral 99% confidence interval over 10 days including a stress period. Two methods are possible: approved quantitative models or standardized schedule (appendices A and B). Models must be validated, governed and can only be used if approved by competent authorities. Risk diversification is allowed within the same asset class, but not across classes (p. 15-19).
- Eligible collateral: A wide range of assets is admitted, including cash, high-quality sovereign securities, corporate bonds, covered bonds, large index equities and gold. These assets must be liquid, diversified, lowly correlated to counterparty risk and subject to appropriate haircuts to reflect market, credit and currency risks, especially during stress. Haircuts can be calculated via models or standardized schedules (appendix B) (p. 20-22).
- Treatment of initial margin posted: Initial margin must be exchanged on a gross basis (no netting) and legally protected, notably by segregation. Re-hypothecation is strictly regulated and limited to one time, with client written consent, regulatory protections and notification requirements. The framework provides for ongoing monitoring and evaluation of these practices (p. 23-25).
- Transactions between affiliated entities: These transactions are subject to regulation adapted to the national legal framework, without imposed international harmonization, due to diversity of local practices and regulations (p. 25-26).
- Interaction of national regimes: The framework stresses cooperation between national authorities to avoid regulatory arbitrage, duplicated or conflicting requirements on cross-border transactions. Rules must be coherent and compatible, with possible mutual recognition between regimes (p. 26-27).
- Established facts: Non-centrally cleared derivatives represent a major systemic risk, with a notional amount around USD 639 trillion in 2012 (p. 7). Bilateral exchange of initial and variation margin is necessary to reduce this risk and promote central clearing (p. 6-9).
- Assumptions: Initial margin calculation relies on an extreme but plausible estimate of future exposure, with a 99% confidence interval over 10 days including a historical stress period (p. 16). Quantitative models must be validated and approved, while the standardized schedule serves as a conservative alternative (p. 16-19).
- Interpretations: Use of models allows a more risk-sensitive approach but requires rigorous governance. The standardized schedule ensures transparency and simplicity, notably for smaller players (p. 17-19). Initial margin must be exchanged on a gross basis and legally protected to prevent re-hypothecation from reducing its effectiveness (p. 23-25).
- Uncertainties: Impact on financial system liquidity will depend on actors' ability to mobilize liquid collateral and international coordination. The monitoring group established will assess these impacts and may recommend adjustments (p. 9-10, 25). Precise definitions of covered entities and application modalities may vary according to national regulations (p. 13-15).
The BCBS and IOSCO have established a harmonized global framework for margin requirements on derivatives not cleared by CCPs, aiming to reduce systemic risk and promote central clearing. This framework rests on eight key elements: instrument coverage, applicability to entities, margin calculation methodologies, eligible collateral, treatment of initial margin posted, affiliated transactions, interaction of national regimes, and phased-in implementation of requirements. Implementation is phased, with an activity threshold of EUR 8 billion for final application of initial margin, and a maximum threshold of EUR 50 million for unexchanged initial margin (p. 8-9, 13-15, 23).
The framework recommends enhanced international cooperation to avoid regulatory arbitrage and ensure consistent application. It emphasizes the need for robust legal protection of initial margins, notably via segregation and strict conditions governing re-hypothecation. A monitoring group is established to assess effectiveness, liquidity impact and international consistency, with the possibility to adjust rules based on feedback and market developments (p. 9-10, 23-27).
National authorities must adapt eligible asset lists and haircuts according to local conditions while respecting principles of liquidity, diversification and low correlation with counterparty risk. Covered entities must rigorously apply approved methodologies for margin calculation and implement robust dispute resolution procedures related to margins (p. 20-22, 16-19).
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