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SIFMA provides comments to the Board of Governors of the Federal Reserve (Federal Reserve), the Federal Deposit Insurance Corporation (FDIC), the Federal Housing Finance Administration (FHFA), the Office of the Comptroller of the Currency (OCC), and the Farm Credit Administration (FCA) - collectively the Agencies.
The Agencies explain that, as part of the international efforts to implement consistent global standards for non-centrally-cleared derivatives, the Agencies intend to consider the final policy recommendations set forth by the BCBS and IOSCO when adopting final US rules for margin for non-cleared swaps. SIFMA members fully support the Agencies in their efforts, through BCBS and IOSCO, to seek to establish internationally harmonised margin rules.
Margin requirements for non-centrally-cleared derivatives are a key component of the overall reform programme initiated by the G20 in 2009. These requirements will potentially have a significant impact on users of non-centrally-cleared derivatives and derivatives market intermediaries and, as a result, the real economy. These impacts will be felt both in times of market stability and, likely with even greater effect, in times of market stress. SIFMA members believe it is critical that international supervisors adopt margin requirements that are consistent and effectively balance financial stability with liquidity and cost trade-offs. SIFMA strongly supports the efforts of the BCBS's Working Group on Margining Requirements (WGMR) to accomplish these objectives.
SIFMA agrees with the WGMR that margin requirements for non-centrally-cleared derivatives can have important systemic risk mitigation benefits. SIFMA also welcomes the WGMR’s recognition that these benefits must be considered in relation to the reduced liquidity that would result from derivative counterparties’ providing liquid, high-quality collateral to meet these requirements. These impacts must, however, be considered in the context of the cumulative impact and interrelationship of other core components of regulatory reform that also have potentially significant liquidity impacts.
These other core components include increased capital requirements, heightened liquidity requirements and single counterparty credit limits. Consider, for example, that new credit value-adjusted capital charges are required to capture dynamic changes in counterparty creditworthiness. Or that expected future exposure computations must be calibrated based on stressed inputs. Increased asset value correlations also capture market stress impacts on asset correlations. Heightened exposure assessments for capital purposes are also now required to capture and reflect wrong-way risk. Significant increases in centrally-cleared swaps arising from mandatory clearing and related margin and guarantee fund requirements will also place further significant demands on market liquidity. And, single counterparty credit limits impose limits on interconnectedness. In fact, both margin rules and counterparty exposure limits address the same issue – counterparty risk. Therefore, SIFMA believes that margin rules should be a fundamental component of counterparty rules and should not be written or implemented as independent requirements.
These regulatory proposals in some ways mitigate systemic risk and, cumulatively, also create enormous demands for effective sequestration of liquid assets. As such, new rules and regulations form part of a comprehensive supervisory mosaic that must be viewed holistically to avoid drastically reducing market liquidity, raising transaction costs significantly for end-users, and ultimately limiting the supply of credit to the real economy.
With these considerations in mind, SIFMA supports the Consultation’s proposal to require the full two-way exchange of variation margin between financial firms and systemically important non-financial firms. SIFMA believes that the daily two-way exchange of variation margin between these firms will enhance financial stability, while also imposing only modest incremental liquidity costs. Such a requirement will also avoid pro-cyclicality by preventing the accumulation of large uncollateralised current exposures of the type observed during the recent crisis and during the late 1990’s. As the WGMR has observed, the net liquidity impact associated with the exchange of variation margin is not likely to be material in the ordinary course of business because it represents a net transfer of value between derivatives counterparties and is not subject to restrictions on re-hypothecation or re-use.
In contrast, the Consultation’s proposal to require the universal two-way exchange of initial margin, on a gross basis and subject to restrictions on re-hypothecation and re-use, would, in addition to raising a number of related concerns and risks, raise significant financial stability concerns due to its associated liquidity impacts. In particular, risk-based initial margin requirements will invariably have a significant pro-cyclical impact in times of market stress, even in circumstances when initial margin requirements are limited in the scope of financial market participants to whom they apply. It must be recognised that future financial shocks are inevitable, and that market resiliency in the face of such shocks must be a pre-eminent and overriding policy objective.
The proposed universal two-way initial margin requirement also goes beyond the measures that are necessary to ensure that interconnected intermediaries have sufficient resources to withstand a major counterparty default without transmitting the resulting losses to third parties. In doing so, we believe the proposal would impose unsustainable strains on liquidity without significant corresponding risk mitigation benefits, and indeed could have potentially destabilising consequences.