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.