The swaps market could suffer disruption if buy side trading firms aren’t ready for the March 1 deadline for the implementation of new margin requirement rules, speakers at SefCon VII warned.
Although buy side firms will not have to post initial margin for uncleared swaps transactions until 2019 or 2020, from March 1, 2017 they will be required to post variation margin when trading these products.
The main challenge highlighted by buy side speakers at the SefCon VII conference in New York on January 18 was the administrative burden of having the correct paperwork and documentation agreed with various counterparties.
They said that, whereas in the past vendors have often been able to produce systems or protocols that enable buy side firms to easily comply with new regulatory requirements that involve complex legal documentation, the bespoke negotiations involved in agreeing how variation margin will be exchanged by two counterparties means that these vendors have been of limited help.
Although the International Swaps and Derivatives Association (ISDA) developed a protocol to help with this documentation, it was developed in association with the banks and many buy side firms have found that it does not address the bespoke issues involved in their variation margin agreements.
As a result, panellists said that many buy side firms are conducting bilateral negotiations regarding the variation margin requirements. They said that this can be extremely time consuming, explaining that if a group of 12 funds has 15 dealers each, then they will have to negotiate with each one of those dealers based on their individual portfolio.
Stephen Berger, managing director, government and regulatory policy at Citadel, also raised the point that the lack of a standardised solution for the buy side could become a problem again in three years’ time when they are preparing to comply with the initial margin rules.
“I can’t blame them, but the banks developed a model largely on their own for trades between each other, that’s the standard initial margin model, and ISDA coordinated that effort,” he said.
Berger said that it was unclear whether the buy side was consciously excluded from this effort or whether these firms ignored the effort because the deadline for implementation is so far off, but said that although this model is now somewhat established and appears to have some degree of blessing from regulators, it might not be suitable for buy side firms.
Equally unclear, said the panellists, is what happens if buy side firms don’t have their documentation in place.
“I don’t know what it means if we do not have the trading documentation in order to trade, does that mean we stop trading? That is obviously not the best result,” said one speaker.
Darcy Bradbury, managing director of DE Shaw, said that the larger dealers were so focused on meeting their own deadline for compliance with initial margin rules that kicked in on September 1, 2016, that they have only recently begun to turn their attention to helping their clients prepare for the variation margin requirements.
“I’ve heard informally that very few customers are actually ready,” she said.
If buy side firms do not have the correct documentation in place by March 1, then it could lead to some of these firms temporarily exiting the market, which one panelist warned could disrupt the swaps market.
Even if the deadline is pushed back by the Commodity Futures Trading Commission (CFTC) to allow firms more time to get their documentation in place, the speakers said that this would only be of limited assistance, because they still have to comply with the regulatory requirements from the various prudential regulators.
One possible solution to this issue that the panellists highlighted is to have a phased in implementation of the enforcement of the new rules.
Regulators in Hong Kong, Australia and Singapore have announced that they will take a six-month phased in approach to enforcing the variation margin rules, with soon to be acting chairman of the CFTC, Christopher Giancarlo, suggesting earlier at the event that this might be an approach that the commission would consider.
In such an approach, the regulators agree not to take enforcement action against firms that do not comply with the rules, provided that those firms show a good faith effort to get all the necessary administration in place.
“As acting chairman, I also intend to look at solutions to ease the March 1st transition in a responsible manner. Look for the CFTC to have more to say about this in the weeks to come,” commented Giancarlo in his keynote address at the conference.
SefCon VII was hosted by the Wholesale Markets Brokers’ Association, Americas, and organised by Profit & Loss.