Staff members of the CFTC Office of the Chief Economist concluded that Phase 5 of the initial margin regime implementation will capture a substantial number of entities with a relatively low average aggregate notional amount ("AANA") of swaps, and with a high proportion of physically settled FX swaps.

The economists prepared the newly released paper as a guide for regulators as they respond to requests for relief by market participants who had argued that Phase 5 (which goes into effect on September 1, 2020) would bring a substantial number of relatively small market participants into scope, and that the costs of implementing these new initial margin ("IM") arrangements would be a significant burden on the industry. The paper provides empirical estimates regarding the coverage of Phase 5.

Specifically, the economists found, among other things, that:

  • Phase 5 could bring 700 entities in scope (versus an estimated 40 for Phase 1), but will encompass only 11 percent of the AANA across all Phases;
  • nearly 60 percent of entities coming into scope in Phase 5 have AANAs of less than $25 billion and over 75 percent have AANAs less than $50 billion;
  • removing physically settled FX swaps from the scope of the AANA calculation could reduce the number of Phase 5 entities by around 30 percent; and
  • compliance with Phase 5 could necessitate implementing nearly 7,000 IM relationships, while excluding physically settled FX swaps from AANA could bring that number down to under 5,000. The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

Commentary / Nihal Patel

The authors' findings largely support the findings from ISDA and SIFMA's recent study.

The methodology of the study, however, is imperfect (as acknowledged by the authors). The data used was based on trade reporting to the CFTC. It excludes security-based swaps (the SEC has no similar reporting requirement) and commodity swaps (due to "data limitations"). In addition, the authors excluded all swaps tagged as "hedging" from the data, but were unable to further determine whether those swaps would satisfy the relevant end-user exceptions from AANA counting requirements.

These data limitations, however, are relevant only at the edges. More generally, the paper's findings add strong support to arguments that the Phase 5 thresholds should be raised. As it stands, the thresholds are likely to cause a substantial amount of unnecessary operational builds and legal costs, given that many market participants brought in scope never even would be required to post or collect regulatory initial margin due to the $50 million threshold baked into the initial margin rules.

Along with the recent comments of CFTC Commissioner Rostin Behnam, the push at the CFTC seems to be toward reconsidering what should happen for Phase 5 in 2020. Unfortunately, the CFTC is only a (relatively) small piece of the regulatory puzzle. The CFTC rules are substantially similar to requirements adopted in concert with a number of regulators across the globe, including the U.S. bank regulators (but not the SEC). Concerted action is needed.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.