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A Primer for Initial Margin Implementation


As new regulations governing margin and collateral continue to be implemented over the next few years, banks and buy-side firms that are well informed about the scope and application of the rules will be best positioned to retool their collateral management practices effectively and on time.


The following primer is intended to help familiarize firms with the key thresholds and parameters that drive compliance with the regulations, which focus on margin requirements for uncleared derivatives and are frequently termed uncleared margin rules. A grounding in these fundamentals can help firms plan for the operational and economic impacts of the emerging regulatory framework.



AANA Calculations


The new initial margin requirements for uncleared derivatives are being phased in around the world in five stages, from 2016 to 2020, based on firms’ AANA, or Average Aggregate Notional Amount. Proper calculation of AANA is therefore a crucial element of rules compliance.


With minor differences by some jurisdictions, AANA is generally the total notional of a legal entity for all products under the uncleared margin rules. (Although FX deliverable forwards will not be collateralized with initial margin in most jurisdictions, that exposure will be included in this calculation.) A firm should measure the notional amount based on average exposure in March, April and May of the year of calculation.


Using U.S. regulations as an example, legal entities are being phased into the regulations according to the following schedule. The new rules kicked in for approximately 30 global banks in phases 1 and 2.


  • Phase 1: September 2016 - $3 Trillion AANA
  • Phase 2: September 2017 - $2.25 Trillion AANA
  • Phase 3: September 2018 - $1.5 Trillion AANA
  • Phase 4: September 2019 - $.75 Trillion AANA
  • Phase 5: September 2020 – All other covered swap entities



Legal Entity Relationships with Affiliates/Parent Groups


Uncleared margin rules apply not only to parent groups and their affiliates, but to related legal entities as well. For example, an asset manager’s seeded funds from its parent investment bank will be subject to the initial margin requirements at the same time as the parent bank. Firms therefore need to factor these legal entity relationships into their implementation plans for new collateral management practices.


Insurance companies that use a separate insurance account structure for their annuity or retirement investment business provide another example. For these firms, the separate accounts, even if each has very small exposure, must start complying with the new rules simultaneous with the insurance company’s general account.


As with the AANA calculation, regulators’ treatment of these relationships will differ somewhat across jurisdictions and firms should note the provisions that affect them.



Initial Margin Threshold


While AANA determines when a legal entity is subject to the initial margin requirements, only when the initial margin between two specific counterparties reaches $50 million must those entities exchange calculations and post collateral to one another.


As an example, if a U.S. legal entity managed by an investment manager has an AANA of $1.5 trillion, it will need to begin calculating initial margin with its counterparties in phase three—that is, as of September 1, 2018.


However, when a legal entity has diversified exposure and initial margin falls below $50 million with some counterparties, it does not need to post or collect initial margin with those counterparties.



Minimum Transfer Amounts


Most regulators have specified that, in their respective jurisdictions, firms will combine initial margin and variation margin to determine minimum transfer amounts (MTAs)—that is, the minimum amount of margin that must be reached before a collateral settlement movement takes place. Combining initial margin and variation margin for the purpose of establishing an MTA is a new concept for many firms. System and operational changes will be necessary to accommodate this requirement.



Separate-Account Monkey Wrench


Besides the phase-in of initial margin requirements for uncleared derivatives, rules for variation margin took effect March 1, 2017—adding complexity to the management of margin across separate counterparty accounts. As a result, documentation disparities, operational headaches, and margin disputes have proliferated.


As more entities begin posting initial margin, similar challenges will arise around calculating AANA and the initial margin thresholds. Insufficient clarity and harmony in the rules across regulatory jurisdictions are exacerbating these problems.


One regulator, the U.S. Commodity Futures Trading Commission (CFTC), has directed that the MTAs can be $50,000, rather than $500,000, for each investment manager’s separate account. But this guidance applies only to entities regulated solely by the CFTC.


Unless regulators across jurisdictions clarify the measurement of MTAs, AANA, and initial margin thresholds for separate accounts, the documentation and operational challenges and disputes investment managers experience with variation margin MTAs will expand when firms have to provide detailed AANA representations on behalf of their clients and manage the initial margin thresholds.


If other regulators fail to adopt a standard for separate accounts similar to the CFTC’s MTA guidance, some investment managers may take a conservative approach to AANA representations and initial margin thresholds, which could negatively impact investment performance.



Planning Starts . . . Now


Even if a firm is not likely in scope for initial margin rules until 2019 or 2020, now is not too soon to begin identifying the documentation requirements and operational workflows for the additional legal entities and accounts that will be covered.


A Credit Support Annex to document the collateral details along with an Account Control Agreement to govern the initial margin segregation will both be necessary along with the operational and system changes. By undertaking this preliminary work, firms can set themselves up for successful implementation.