15 March 2013

ALFI comments on BCBS's/IOSCO's Margin Requirements for non-centrally cleared derivatives consultative document

ALFI believes that a two-side initial margin requirement would significantly increase systemic risk due to the liquid capital backing of a very large number of currencies and volumes.

ALFI believes that such a full exemption should only be permitted for transactions with a short-dated maturity such as three months and less longer-dated transactions increases, ceteris paribus, the settlement risk. Therefore, ALFI would recommend that each counterparty to such a transaction should assess whether, at which point in time and to what extent it deems necessary to request collateral as it also depends significantly on the currency under consideration when and to what degree settlement risk becomes material  beyond the three-months period.

Physically settled FX forwards and swaps with maturities of more than three months should be generally included in an individual collateral programme of a counterparty. ALFI does not believe that the current proposed regime for other non-centrally cleared derivatives should be systematically applied for physically settled FX forwards and swaps. ALFI would rather strongly recommend requiring any counterparty to establish its own collateral management policy and procedures in this respect. Those could consider currency and market specific properties such as volatility or liquidity. ALFI believes it is more appropriate to have a principle-based framework for the – predominately – settlement risk as different exposures to different currencies are exposed to market risks to different degrees subject to the specific nature of the different currencies. Considering the very specific nature of the various FX-markets, but also appreciating that physically-settled FX swaps and forwards may inherently bear some sort of risk, such transactions should be subject to a counterparty’s individual collateral management programme backed by a strong own risk management.

ALFI is of the opinion that cash must be re-invested or re-deposited in any case as cash cannot be segregated for legal and operational reasons. Thus, if there is no re-investment possibility for cash, the posting party faces significant default risk as regards the collateral  collecting party.

ALFI would recommend aligning the phase-in periods for initial and variation margin requirements. ALFI agrees that a certain variation margin system is currently in place, but it will take some time to implement and adopt the new specific requirements effectively, particularly developing and testing new internal models, which enhance the current regime. ALFI believes January 2015 should be the earliest starting date, but it would prefer a later phasing-in aligned with the phasing-in for the initial margin system.

Full response

© ALFI - Association of the Luxembourg Fund Industry