In response to the COVID-19 pandemic, 21 financial industry associations have submitted a letter on behalf of their members requesting BCBS (Basel Committee on Bank Supervision), IOSCO (International Organization of Securities Commissions), and other global regulators to suspend the current timeline for the initial margin phase-in. The letter says this will to allow market participants to focus their resources on ensuring continued access to the derivatives market.
Regulators globally have established standards for uncleared margin rules (UMR) for derivatives to be phased in over time and, having taken feedback from the industry, continue to take actions to confirm and codify these requirements.
While stressing that the associations and their members are “very appreciative” of the steps taken by BCBS, IOSCO and global regulators to address the challenges of the final phases of UMR and noting that market participants have been working diligently to meet these compliance dates, the associations say these efforts are being “severely impacted” by the global COVID-19 pandemic. “Our members do not believe it is possible or practicable to meet documentation and operational requirements for the regulatory initial margin (IM) compliance dates on September 1, 2020 (Phase 5) and September 1, 2021 (Phase 6),” the letter states. “We respectfully request that BCBS and IOSCO issue an immediate, public recommendation to global regulators to suspend the compliance dates for Phase 5 and 6, and that global regulators act swiftly to provide corresponding reassurance in their jurisdictions while they work to address necessary rule amendments or other means to effect this decision.
“As the overall impact of COVID- 19 may not be known for some time, we suggest that decisions regarding a new timeline for the implementation of further phases of the IM requirements be delayed and reconsidered when relevant facts and circumstances are known,” the letter continues. “When markets are back to normal conditions and new Phase 5 and Phase 6 compliance dates are to be set, we kindly request that sufficient lead time be provided in order to complete implementation in a phased and reasonable period.”
The letter further notes that while the associations’ member firms have robust business continuity plans in place that are generally functioning well, given the overwhelmingly disruptive nature of the current epidemic, their efforts to prepare for the final phases of regulatory IM have been severely impacted due to personnel, systems and other issues. Most notably this is due to the displacement of staff, due to pandemic precautions and to meet other tasks related to the increased market volatility. “These challenges are expected to worsen as markets continue to fluctuate, lockdowns broaden, and staff are compromised by illness or need to care for family members,” the letter states. “Due to market volatility, firms are avoiding infrastructure updates and may be unable to complete, deploy or test infrastructure needed to support regulatory IM requirements.”
Although the next formal regulatory deadline is September 2020, the associations note that there are critical near-term deadlines during Q2 – particularly in respect of custodial onboarding – which will be impacted and have a knock-on effect on the ability of Phase 5 firms to meet the September deadline.
Additionally, while firms need to complete custodian documentation, the custodians are subject to the same strained working conditions as the firms coming into scope. “We note that the ability of global custodians to facilitate client onboarding is already being impaired, extending further the lengthy process to establish compliant custodial accounts,” the associations say. “Similar challenges are likely to affect the availability of vendors which provide services critical to IM implementation.
“Our members are also concerned about the electronic execution of agreements,” the letter continues. “Electronic execution is a means of signing virtually rather than by way of a usual ‘wet ink’ signature which is scanned and exchanged. Electronically-executed agreements may not be enforceable in every counterparty jurisdiction (as a matter of local company law) and would need to be diligenced on a case-by-case basis. Therefore, given the industry is almost entirely working from home at present, getting documents physically signed and scanned could pose an obstacle to the timely execution of regulatory IM documents by all contracting parties.
“In current circumstances, operational teams are working at full capacity to ensure proper business continuity,” it adds. “Run-the-institution activities have full priority over change-the-institution activities. On this basis, it will be very challenging for the industry to complete steps necessary to comply with UMR even prior to IM exchange, including average aggregate notional calculations and computation tools for margins. Without action by global regulators, it is almost certain that sections of the market would get shut out, increasing risk to investors.”
Highlighting how firms’ priorities in current conditions are “deeply focused” on credit and market risk management, the associations reiterate their belief that efforts to minimise losses from the current crisis should take precedence over preparations to address the potential risk of future exposure from small market participants. “Moreover, we emphasise that, if during this historically volatile time, firms divert internal resources away from managing their risk and portfolios and instead focus on implementation of UMR, investors may be adversely affected,” the letter states. “In the meantime, the exchange of regulatory IM amongst the largest market participants will continue to mitigate systemically important derivatives market exposures.”
Whilst reiterating their appreciation for the steps already taken by regulators to engage with the industry and mitigate the risks thereto, the associations conclude by warning, “Without timely and, to the greatest extent possible, globally consistent regulatory action in respect of UMR, there will be insurmountable hurdles to implementation for many market participants, limiting access to the derivatives market at a time when they are most greatly needed to hedge financial risk, including related market volatility.”