ISDA criticises 'flawed' initial margin plan for derivatives trades
GLOBAL – Imposing initial margins on counterparties in non-centrally cleared derivatives trades is "flawed" and will not necessarily reduce risk, the International Swaps and Derivatives Association (ISDA) has claimed.
In a statement, the association welcomed the posting of variation margins for non-centrally cleared derivatives trades and said the practice of frequently exchanging the unrealised mark-to-value fluctuations between two parties has proved to be beneficial in reducing counterparty risk.
However, it argued against the posting of initial margins for such trades and said that even a rudimentary risk/benefit exercise showed that the approach was "flawed".
"We see minimal benefits in terms of incremental risk reduction – above and in excess of what is already provided by capital requirements," it said.
"Instead, we see huge risks in the making. The outright quantum of margin required under these proposals, even in 'normal' market conditions, is significant."
The association based its comments on the data of the QIS study the Basel Committee on Banking Supervision (BCBS) and the International Organization of Securities Commissions (IOSCO) are currently conducting.
Even if market participants take the most optimistic scenario, where all market participants use some form of internal model, ISDA estimates incremental margin requirements at approximately $80bn (€61.3bn).
It pointed out that this amount of incremental collateral would be "challenging" to raise, even under normal circumstances.
The trade organisation went on to say that initial margin requirements in stressed conditions could go up by at least three times, raising potential requirements at a time when liquidity would be in high demand.
"This is a clear recipe for disaster, only exacerbating systemic risk," it said. "And as to the proposed use of thresholds to alleviate the initial margin impact, at times of crisis, they just make the problem worse."
ISDA instead calls for a three-pillar framework for ensuring systemic resiliency, which would consist in a robust variation margin framework, mandatory clearing for liquid, standardised products and appropriate capital standards.