By Blake Estes, counsel in Alston & Bird’s Financial Services & Products Group – Following the financial crisis, the Basel Committee on Banking Supervision and the International Organisation of Securities Commissions (IOSCO), as directed by the G-20 countries, developed consistent global standards for margin requirements for uncleared derivatives to reduce systemic risk in the derivatives markets.
Derivatives regulators across the globe, including in the US, have used these margining standards to develop their own local margin rules to be implemented over five phases, with the first phase beginning in September 2016 and the fifth and final phase due to commence on 1 September 2020.
With each successive phase, the net widened to apply the new margin rules to more market participants based on average aggregate notional amount (AANA) over the course of a 12-month period. The first four phases captured the largest, most-active trading parties and the vast majority of global derivatives activity.
The fifth and final phase was set to substantially reduce the AANA threshold from USD750 billion to USD8 billion for US market participants, covering over 600 additional trading parties, including many buy-side investment firms. Industry participants refer to this final phase as the initial margin “big bang” because of its scope, affecting many more market participants than all prior phases combined.
To comply with the new margining rules, trading parties will, generally, be required to amend legacy trading documents and otherwise prepare systems for new collateral posting obligations. Given the number and profile of firms – smaller buy-side participants rather than large global banks – to be brought into scope upon implementation of the fifth phase, the industry raised concerns that many firms would not be ready to comply by the September 2020 deadline. Failure to comply would potentially render those firms without access to the over-the-counter derivatives markets.
In order to avoid market fragmentation and disruption, on 23 July 2019, the Basel Committee and IOSCO decided to effectively split the final phase into two, introducing a new fifth phase with an intermediate threshold of USD50 billion in AANA and postponing implementation of the final (now sixth) phase by one year.
With the introduction of the sixth phase, full implementation of the rules will not occur until September 2021, when the AANA threshold is finally reduced to USD8 billion. The postponement, which is expected to reduce the number of in-scope firms in September 2020 by more than half, will allow for more time to educate market participants about the new requirements and for them to prepare to comply.
As was the case with the original timeline, the new schedule will only become effective in each G-20 jurisdiction after it has been formally adopted by the relevant regulators for that jurisdiction. For the US, the Commodity Futures Trading Commission (CFTC) and the prudential banking regulators must enact changes to their margin rules for uncleared derivatives to implement the adjusted implementation for US market parties.
While the postponement is viewed as beneficial, perhaps even essential, by many market participants, the new deadline forestalls the day of reckoning for only one year and, for many, notably smaller buy-side firms, there is still a significant amount of work to be done to ensure compliance. For buy-side firms, this delayed implementation should not be viewed as an opportunity to postpone undertaking the necessary work for another year; rather, those firms have now been afforded the additional time necessary to ensure compliance if they start preparations now.
