CFTC clarification on UMR and the 50mm
Matthew Kulkin at the CFTC has issued a letter amplifying the guideance from BSBC / IOSCO on how to handle a relationship which is beneath the 50mm IM threshold. The advisory applies only to Covered Swap Entities (CSEs). The CFTC Margin Rule does not require counterparties to CSEs, other than other CSEs, to establish custodial services, document margin relationships, or operationalize the exchange of IM. Therefore, this advisory is not applicable to non-SD counterparties and does not address any obligation of such counterparties or suggest any such obligations.
On March 5th BCBS IOSCO said:
The framework does not specify documentation, custodial or operational requirements if the bilateral initial margin amount does not exceed the framework’s €50 million initial margin threshold. It is expected, however, that covered entities will act diligently when their exposures approach the threshold to ensure that the relevant arrangements needed are in place if the threshold is exceeded. 
The CFTC letter said:
This advisory clarifies that while no specific IM documentation is required prior to reaching the $50 million IM threshold, DSIO expects that CSEs will take appropriate steps to have the required IM documentation upon reaching the IM threshold.
Commission regulation 23.504 directs CSEs to take appropriate steps to ensure the timely execution of IM documentation required by the CFTC Margin Rule, such that a CSE must complete the documentation by the time it reaches the $50 million IM threshold.
CSEs must therefore have an appropriate risk management system to calculate and monitor IM amounts and must act diligently as such amounts approach the $50 million IM threshold, so that they can ensure compliance with the IM requirements and have all required IM documentation in place once IM amounts reach such level.
DSIO believes that the above-referenced rules collectively require the execution of IM documentation when the collection or posting of IM is actually required; that is when the $50 million IM threshold is exceeded. In this regard, DSIO points to the Commission’s statement in the preamble to the CFTC Margin Rule that “[t]he final rule does not require a CSE to collect or post initial margin collateral to the extent that the aggregate un-margined exposure either to or from its counterparty remains below $50 million.” 20
DSIO notes that Commission regulation 23.504 requires the execution of IM documentation “prior to or contemporaneously with entering into a swap transaction.” However, the IM documentation is required only if there are any IM requirements and any custodial arrangements. Accordingly, to the extent the $50 million IM threshold is not exceeded, there are no applicable IM requirements, and no need for any pertinent documentation or custodial arrangements.21
For firms who might have relationships below 50mm - the situation isn't so simple in reality. Before you can establish the level of IM itself you need to complete implementation and approval of an IM calculator - and then put in place a strategy for montoring and measuring IM.
This is exactly the topic of our webinar coming up next week on Tuesday 16th which explains the subtleties of handling the 50mm threshold.
Firms in-scope under UMR - due to their average notional being above the threshold- but are below or nearing the 50mm threshold on a counterparty relationship basis, do not initially need to post IM.
While these firms are not required to set up operational processes, they do have an obligation to monitor and manage their IM levels to make sure they do not breach the 50mm threshold.
Remember, should your firm surpass the 50mm threshold, you must achieve compliance with UMR immediately, including all necessary margin agreements with your counterparties and suitable custody arrangements for settlement.
Therefore, pre-trade controls are essential and gives firms the ability to check the IM impact on their portfolio to ensure it stays comfortably below that 50mm threshold; not only to ensure they do not breach but to also make sure any other portfolio or market movement will not change the IM profile on that agreement.
Our panel will discuss
- How can firms use the $50m/€50m threshold to reduce their UMR compliance approach?
- How should a firm determine the IM threshold amount both for themselves and their counterparties?
- What are the consequences of going over the $50mm threshold?
- How should a firm organise themselves to monitor and manage their approach to the $50m threshold?
- What options are available to firms to reduce their IM?
More insight here
Nick Railton-Edwards of DRS has further insights into this letter - taking a more critical view of how this affects firms.
- 1 BCBS/IOSCO statement on the final implementation phases of the Margin requirements for non-centrally cleared derivatives (March 5, 2019), https://www.bis.org/press/p190305a.htm.
- 20 Margin Requirements for Uncleared Swaps for Swap Dealers and Major Swap Participants, 81 FR at 652.
- 21 While CSEs and their counterparty may enter into custodial arrangements in anticipation of meeting the $50 million IM threshold, the arrangements are not required until the threshold is exceeded. The Commission also notes that once a CSE and a counterparty exceed the $50 million IM threshold, even in the event that the IM amount subsequently falls below the threshold level, the CSE must still meet all the above IM documentation requirements.