As asset managers continue their preparations ahead of the final phase of UMR, Phil Hermon, Executive Director, FX products at CME Group explains why the intricate details behind ISDA SIMM 2.4 really do matter.

As asset managers continue their preparations ahead of the final phase of UMR, Phil Hermon, Executive Director, FX products at CME Group explains why the intricate details behind ISDA SIMM 2.4 really do matter.

It may have slipped under the radar for some, but during December 2021, a new ISDA SIMM model came into force. The new governing model, ISDA SIMM 2.4, has several fairly material changes that may impact on the initial margin (IM) requirements clients pulled into UMR have to post. The headline changes incorporated in to ISDA SIMM 2.4 for FX products include: the inclusion of post-pandemic related market volatility from Q1 2020, certain currencies being labelled as “high volatility” with higher associated risk weights (these include BRL, MXN and ZAR), and the vega weighting component receiving a more than 50% increase (serving to increase the IM on FX Options).

Research from Clarus, on seven different portfolios concluded that the new model would result in a >10% increase in the regulatory IM required for most portfolios. While other research from OpenGamma suggests that initial margin efficiencies ranging from 39% to 86% can be achieved through FX options.

Since phase 5 of UMR came into effect in September 2021, CME Group has experienced several all-time records in FX options. Overall growth in Q4 of 2021 was particularly strong with FX options volumes up 18% year-on-year and average open interest up 34% year-on-year. However, this is not the only driver of listed FX products. Regulations such as SA-CCR, RWA and CCAR have all played a part. Customers continue to cite several benefits of using this instrument including the removal of counterparty credit risk and ease of access given no need for an ISDA.

In December 2021, OpenGamma conducted an FX options analysis looking at the IM that would be required for a position held as a listed FX Option at CME versus a bilateral position margined using ISDA SIMM 2.4. The findings (listed below) are a subset of that analysis and assume a non-delta hedged portfolio of EUR/USD FX options totalling $10m notional, held across five counterparties for the bilateral scenario. Material efficiencies for the listed portfolio can be seen across all the four scenarios, with the starkest difference being on the long call positions. This is where the CME Group model for listed FX options utilises the concept of “equity style premium”. This in turn means that the premium paid shows up as a ‘credit’ that is off-set against the margin required – which in these scenarios resulted in the long holder having to pay zero IM. In contrast, firms would have to pay both the premium to the short holder as well as the regulatory IM calculated by ISDA SIMM in the bilateral world.

The one off/tactical impacts of UMR (e.g., setting up new ISDAs and custodial arrangements) combined with the ongoing tasks that require resourcing (e.g., daily calculation, reconciliation and funding of IM) may well present real challenges to real money accounts– especially as Phase 6 of UMR (with a $/EUR 8bn threshold) comes in to force in September of 2022.

While September seems like a way off, asset managers will be part way through their preparations now. One solution open to all market participants is the use of listed FX products to remove the gross notional traded from the AANA calculation and optimise the initial margin requirements. CME Group operates an established marketplace with significant FX liquidity as proven with open interest at $259bn and customers holding 1,262 large open interest positions (as of 11 Jan 2022).