Template:M summ 2018 CSD 3(c)(iii)

The point where, with the greatest of respect, the 2018 English law IM CSD gets totally over the front of its skis. Had it just reined in its enthusiasm, and limited itself to dealing with *just* regulatory IM, that actually has to be posted, compulsorily, to a third party custodian, this document would have been shorter, less controversial, and way easier to understand. But no: ISDA’s crack drafting squad™ went into bafflement overdrive.

A casual reader might also wonder whether someone is having a laugh. If ISDA’s crack drafting squad™ wanted to, they could scarcely have made this more convoluted, as our nutshell summary should indicate.

The problem ISDA’s crack drafting squad™ was trying to “solve for” was the kind of counterparty who is already taking initial margin and wants to keep doing that, somehow, even now the technocrats have railroaded their way into this age-old process and mandated it by regulation. These include, for example, prime brokerage clients, who might have swap positions “cross-margined” with a wider range of physical and futures positions that the PB will want to margin and rehypothecate against in one place.

But it might be as simple as a dealer who has set independent amounts higher than those mandated by the regulators, and wants to keep them.

So the 2018 English law IM CSD contemplates, on one hand, regulatory initial margin, which it calls “Margin Amount (IM)”, and non-regulatory initial margin, which it labels with fond redolence to the old days of Independent Amounts, as “Margin Amount (IA)”.

The theory

Let’s call your existing, pre-regulatory initial margin arrangement your “IA”, and the regulatory requirement “IM”. IA could be more than IM, less than IM, or (unlikely, but let’s say) the same.

The other difference is that usually you paid your IA directly, and by title transfer, to your counterparty. Since generally dealers would require IM, but customers would not, this had the curious effect of increasing the customer’s credit exposure to the dealer, at the same time it reduced the dealer’s market exposure against the customer. But — and for that very reason, Reg IM you must pay not to your dealer, but to a third-party custodian, subject to a security arrangement and an account control agreement, to avoid exacerbating counterparty credit risk the other way. The regulatory regime is therefore economically not the same as the previous non-regulatory IA regime, as the recipient cannot monetise the regulatory initial margin it receives, or use it elsewhere in its business. This reuse right is important for those involved in margin lending.

So once the Reg IM comes in, the question becomes (a) do you still want your old IA delivered to you so you can reuse it — in total, or just any of it in excess of the new IM requirement?

The 2018 English law IM CSD proposes three ways of solving this:

• Distinct Margin Flow Approach: you pay IM under the 2018 English law IM CSD and pay the whole IA whack, separately, to the counterparty under the Other CSA. Obviously enough, customers are not going to like this.
• Allocated Margin Flow Approach: you pay the Reg IM portion of the IA under the 2018 English law IM CSD, and pay any excess over that in the IA to the counterparty under the Other CSA. To the JC’s way of thinking, this is the only one that makes any sense;
• Greater of Margin Flow Approach: You pay the whole of the IA (or the IM, if it is greater) under the 2018 English law IM CSD and nothing under the Other CSA. We don’t think the broker will ever give up the right to reuse excess IA by steering that to a third party custodian, and nor, really should the client, since their implied financing rates will surely rise.