Jan 21, 2014

Exploring the ISDA Standard Initial Margin Model

To further facilitate the introduction of the final BCBS-IOSCO guidelines for margin requirements for non-centrally cleared derivatives, last month ISDA released a consultative paper proposing a standard initial margin model methodology. In this video blog, Satyam Kancharla, SVP of the Numerix Client Solutions Group provides an overview of the proposed framework, including key criteria, goals and potential challenges. He also discusses how it aligns with current CCP margin models for centrally cleared derivatives

Weigh in and continue the conversation on Twitter @nxanalyticsLinkedIn, or in the comments section.

Video Transcript: Exploring the ISDA Standard Initial Margin Model

Jim Jockle (Host): Hi welcome to Numerix Video Blog I’m your host Jim Jockle. Joining me today, Senior Vice President of the Client Solutions Group here at Numerix, Satyam Kancharla. Satyam welcome.

Satyam Kancharla (Guest): Hi Jim.

Jockle: I want to talk about the recent publishing in December of 2013, the ISDA document in terms of standard initial margin model for non-cleared derivatives. And this was really a follow up to BCBS and IOSCO paper that came out on September 2nd really around the margin requirements for non-centrally cleared derivatives and as part of that directive, ISDA published a nine criteria guideline. But also has some challenges based in here as well. Could you give us a quick overview of some of the criteria and what this document is meant to accomplish at this point.

Kancharla: So well as you know, the Basel Committee and IOSCO came up with this regulation for bilateral margin or the mandated margin as a methodology for handling and reducing counterparty risk for bilateral trades as well. We know for all cleared trades margining is already in place and all the CCPs are implementing the margin models and banks are implementing margin models, etc. But what the BCBS paper has cleared is the requirement for margin in the case of bilateral models as well, in the case of bilateral trading as well.

And as a result, as we all know these trades are quite complex and there’s a lot of variability in terms of how they’re priced, and on top of that if you add the variability that comes into the picture because of the margin model itself, and there are so many different options around how the margin model can be built. It could lead to a lot more confusion in the market. It could lead to disputes around the pricing and the margin calculations. And it could further make the OTC market structure further complicated and difficult for participants which is why ISDA has come up with this principles paper around creating a standard margin model and they’ve identified some criteria of what this standard model might be.

Jockle: Now one of the key things and the margin calculation requirements by the central clearers is proprietary to them, but this mimics some of the standard requirements that market participants are facing when facing off against the clearing house, is that correct?

Kancharla: Absolutely. There is definitely a flavor to this whole margin model which is aligned with and similar to what we have seen in CCP’s and also prior to CCP clearing for swaps, even for the swap span model around futures and so on. So the goal of this model is to keep the calculations more or less in alignment so that we can have apples to apples comparison. We can have some kind of a standard, but of course this would apply to bilateral trades whereas the CCP models would apply to centrally cleared trades.

Jockle: So one of the questions I have though is the document really also highlights a lot of the challenges there are in achieving this standardized initial margin model. And one of the things in terms from when I look at it is, the keyword is standard. Right? So yes we have standardization as it relates to interest rate swaps. We have standardization against the stack convention. What are going to be some of the challenges other instruments are thriving under this umbrella or quotes of standardization?

Kancharla: Exactly. I think what you’ll see in the paper itself and also the studies that have been done is that there is so much possibility of variation that the impact of this margin process could be somewhere between half a trillion to 8 trillion Euros. So that just tells you how much the variability can be just at the macro level in terms of the margin calculations. Now why is this variability taking place and why is this variability in the model? That’s because first of all we must realize that these are the hard to clear or the unclearable trades. So whereas in the CCP world, we’re still talking about standard swaps and swaptions, and instruments like that.

Here we’re talking about multi asset derivatives, cross asset hybrid derivatives, equities, commodities, etc. So the product complexity is one, the risk factor complexity is another, and then the VaR model, versus expected short fall, having the exact definitions for risk factor upsets. Using greeks or not using greeks, so there are a number of possibilities in terms of how this margin model can be implemented and that’s where there’s a lot a variability and ISDA is rightly looking to make sure that we streamline that and have some kind of an industry standard.

Jockle: So clearly ISDA we’re following where the central clearers are in terms of a similar model. But for bilateral trades how does this play into the adaptation of the standard CSA. If we’re thinking on the opposite side of the trade in terms of the variation margin, how are the two interacting together?

Kancharla: Oh definitely I think having a standard CSA really helps to streamline some of these calculations because obviously the margin is supposed to provide a cover for any kind of systemic shock or counterparty shock and having clear definitions around CSAs and standard definitions around CSAs reduces complexity around optionality the CSA. And that will help to remove some of the complexity. Of course there is a lot of availability in the margin model beyond what goes into a CSA, but having a standard CSA will definitely help to reduce the complexity.

Jockle: Okay. Well Satyam we’re definitely going to talk about this a little bit more and I do want to jump down into different elements of the criteria. There’s a lot to discuss, but we’ll save that for the next video blog. So we want to talk about the things you want to hear about. So please again, follow us on twitter @nxanalytics or on our blog and let us know so we’re covering all the elements. I’m going to ask you back into this chair one more time and we’re going to break down into the nine elements of criteria. And with that I’d like to wish everyone a good afternoon. Thank you.

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