SIFMA agrees with the Working Group that margin requirements for non-centrally-cleared derivatives can have important systemic risk mitigation benefits. The association also welcomes the Group’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 significant liquidity impacts, including increased capital requirements, heightened liquidity requirements and single counterparty credit limits.
For example, new credit value-adjusted capital charges are required to capture dynamic changes in counterparty creditworthiness and 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.
SIFMA pointed out that both margin rules and counterparty exposure limits address counterparty risk. Thus, 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 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 Working Group’s proposal to require the full two-way exchange of variation margin between financial firms and systemically important non-financial firms. The daily two-way exchange of variation margin between these firms will enhance financial stability, said SIFMA, while also imposing only modest incremental liquidity costs. Such a requirement will also avoid pro-cyclicality by preventing the accumulation of large uncollateralized current exposures of the type observed during the recent crisis. 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, however, SIFMA said that the 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 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. Recognizing that future financial shocks are inevitable, SIFMA said that market resiliency in the face of such shocks must be a pre-eminent and an 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, observed SIFMA, the proposal would impose unsustainable strains on liquidity without significant corresponding risk mitigation benefits, and could have potentially destabilizing consequences. Thus, SIFMA recommended modifications to the proposals that are intended to align margin requirements with the mitigation of systemic risk, while minimizing adverse liquidity impacts. In particular, SIFMA believes it is critical that further analysis be undertaken with respect to the impact, benefits and potential structure of any initial margin requirements or alternative analogues.