Stabilized initial margin with a catch – Understanding the impact of SIMM recalibration

Recent increases in market volatility have fueled an increase in the costs of trading, specifically the collateral held due to bi-lateral initial margin (IM) on OTC transactions. While IM exposure has stabilized overall, certain risk factors have risen significantly due to the annual recalibration in December 2022. IM requirements under the Uncleared Margin Rules (UMR) for bilateral trading were a key component of post-financial crisis reform – aimed at creating greater stability. The implementation was phased in over six years, from 2016 to 2022. The largest firms were included in the first phase, while smaller firms were in subsequent phases. This requires organizations to post collateral daily to cover the potential loss of counterparty default.

ISDA’s SIMM™ model, the most widely used methodology, calculates an exposure that can cover the margin requirement to a 99% degree of confidence over a 10-day MPOR. This model is updated annually based on industry backtesting and benchmarking, and the latest revision includes the period January 1st, 2021, to December 31st, 2021. Acadia has estimated for parts of its client base an increase of around 6% in the cost of margin, but with some risk factors causing up to a 50% increase in exposure in some areas

Stabilization of Overall Exposure Levels

Acadia uses the ISDA SIMM™ methodology to determine the level of IM exposure for over 400 clients daily, providing valuable insights into IM reconciliation. This rich source of data can also be used to observe the effects of SIMM™ recalibration across the industry. Chart 1 illustrates the average daily USD exposure of all firms in the 2 months before and after the recalibration at the end of week 48.

Margin levels have seen noticeable stabilization in aggregate. Comparing the step function to a straight line, it is evident the data is better fitted to a gradual increase in exposure over time. Chart 2 highlights the average change per phase in USD exposure before and after the recalibration.

Firms have seen between a 2% and 9% increase in USD exposure, with an industry-wide change across phases 1-5 of 6%. The newly introduced phase 6 portfolios are still growing rapidly. This natural increase in exposure makes it difficult to identify the increase due to recalibration and as a result, it has been excluded from the analysis above.

Increased Exposure Levels of Specific Risk Factors

European Natural Gas and the Russian Ruble

The inclusion of the buildup to the Ukraine War in this year’s recalibration had a significant effect. The commodity exposure tied to European natural gas pre-December 2nd averaged USD 1.35 billion, and post December 2nd it averaged USD 2.55 billion. Europe’s energy dependence on other countries resulted in higher commodity risk weights this year. Similarly, FX exposure tied to the Russian ruble pre-December 2nd averaged USD 436 million, and post December 2nd it averaged USD 616 million. Russia’s current position is incredibly unpredictable, and as a result, its currency moved into SIMM™’s high FX volatility group.

Firms have seen up to a 38% increase in European natural gas USD exposure, with an industry aggregate across phases 1-5 of 22%. Likewise, firms have seen up to a 50% increase in USD exposure tied to the Russian ruble, with an overall change across phases 1-5 of 42%. While these changes have been dramatic, it’s only likely to be a pre-cursor to what happens in the next recalibration, where the full effects of the market turbulence will be included.

The policy of annual recalibration rightly delivers on the requirement of non-pro-cyclicality, but the particularly long delay of 22 months between events that happened in February 2022 and the implementation of the recalibration in December 2023, has meant that there have been some calls to increase the frequency of recalibrations.

High Yield & Non-Rated Bonds

Credit qualifying risk linked to high-yield and non-rated bonds, including government-backed financials, averaged USD 3.34 billion before December 2nd and USD 4.59 billion after that date. Uncertainty surrounding many central banks’ abilities to ward off recession caused OTC transactions with these types of underlies to become more costly.

Firms have seen between 18% and 37% increase in high yield and non-rated USD credit exposure, with an industry aggregate across phases 1-5 of 28%.

Outlook: Managing Risk

Recent market shocks, mainly interest rate spikes, may further increase credit exposure in future recalibrations. Central banks continually raising base rates to curb inflation will also further drive up funding costs. This highlights the importance for firms that are in-scope of UMR to have a thorough understanding of their position.

For firms above the USD 50 million threshold, tools for comparison before and after recalibration, especially if the yearly cycle shortens, are crucial to ensure preparedness for changes in margin activity. For firms below the USD 50 million threshold, it is important to use tools for exposure monitoring as well as pre-trade analysis to fully understand the costs of new trades. Exposure optimization is always critical for keeping portfolios below threshold where possible. Not acting can result in far higher costs and a greater risk of future increases, making it increasingly important for industry participants to regularly measure and actively manage the costs of posting initial margin

About the Author

Jacob Ullman joined Acadia in 2020. In his role, Jacob is responsible for the data analytics that drive the strategy across Acadia’s suite of solutions. He has focused primarily on the launch of Acadia’s data exploration (DX) to give clients the power to make data-driven decisions. Jacob holds a Certificate in Quantitative Finance from the CQF program and two Bachelor of Science degrees (BScs) in Finance and Mechanical Engineering from Lehigh University