Swaps Collateral Rules Put Market at Risk of Splintering

Updated on
  • European Union sticks to March 1 deadline for variation margin
  • ISDA says many users of derivatives may not be ready on time

Global regulators’ plans for a coordinated start next month to swap-collateral rules are breaking down, with countries taking different approaches to the deadline and traders in the $544 trillion industry scrambling to get ready.

The European Union plans to stick to the March 1 start date, and regulators have little power to quickly adjust laws after they go on the books, according to an EU official. In Hong Kong, Singapore and Australia, authorities granted the industry six months to phase in the requirement, eager to avoid a messy start to a key policy intended to make the market safer following the 2008 financial crisis.

In the U.S., the picture is even more complicated. The acting chairman of the Commodity Futures Trading Commission, who took over after President Donald Trump was inaugurated, said the deadline is unrealistic and wants to find a way to smooth the implementation of a rule that seeks to bolster the financial system by forcing banks, asset managers and other traders to hold more collateral to protect against risks stemming from a deal going bust.

““We’ve been raising attention to the fact that the industry faces a real challenge to meet the March 1 deadline,” said Scott O’Malia, chief executive of the International Swaps and Derivatives Association. “As it stands, it looks likely that many derivatives users will be unable to access the derivatives markets from March 1, unless there’s some form of regulatory action.”

Financial Crisis

Small differences in the timing and substance of regulations can mean major money in the swap market, and the flap over the March date shows the continued difficulty regulators have in coordinating oversight and ensuring a level playing field to prevent traders from rushing to do business in the jurisdiction with the laxest rules. The Financial Stability Board, a panel of regulators from around the world, last year called for urgent action by authorities to ensure the market didn’t fragment along national lines.

The collateral requirement is one of the bedrocks of global regulatory efforts to curb risk in the market after swaps were blamed by lawmakers for fueling the financial crisis. Authorities around the world pushed for banks, asset managers and other traders to have cash, securities and other collateral for derivatives to protect against the threat that one trader’s default could spread risk throughout the financial system.

The international standards were completed at the global level in 2015 and then written into national laws before beginning to take effect. While part of the rule was implemented in certain jurisdictions in September, the March 1 date applies to a much wider range of firms and requires they exchange collateral known as variation margin to cover daily market swings.

‘Not Ideal’

For the EU to modify the deadline, it would have to amend the relevant legislation, a process that would take months, the EU official said. There is also no mechanism that would allow the bloc’s supervisors to exercise forbearance, the official said.

“There remains a huge amount to be done,” said Emma Dwyer, a partner at Allen & Overy in London. “The scale of documents that still need to be re-papered and put in place is very, very high. The chances of it getting done are extremely remote.” The prospect of key jurisdictions departing from the deadline is “not ideal,” she said.

ISDA and other industry groups have referred to March 1 as the “big bang” start date for margin requirements.

“I am especially concerned that smaller firms, including American pension and retirement funds, may not be able to get their documentation done in time,” J. Christopher Giancarlo, acting CFTC chairman, said on Jan. 18. “If they do not, they will be abruptly forced to stop hedging their portfolios at a time of enormous changes in financial rates and global asset values.”

Asset Managers

Giancarlo said he approved of the policies in Asia to ease the transition and that the CFTC will say more on the matter soon. The CFTC, the main U.S. derivatives regulator, shares power on the rule with other regulators, including the Federal Reserve, that have kept mum so far on the timetable.

Lobbying groups for asset-managers and retirement funds say the industry simply isn’t ready to meet the March deadline. The asset-management arm of the Securities Industry and Financial Markets Association and the Investment Adviser Association conducted a survey of members that found firms still face a “massive” challenge to rework legal agreements that can cover thousands of client accounts for pensions, hedge funds, private equity firms and other types of investment funds.

“Asset managers, as fiduciaries serving these investors, continue to have concerns about their ability to hedge, manage investment risks, implement investment strategies and achieve best execution on behalf of their clients,” the groups wrote in a Jan. 24 letter to a dozen global regulators.

(Updates with comments by EU official in eighth paragraph.)
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