Article 1: Introduction to Liquidity Preparedness for Margin and Collateral

Recent market upheavals, from the COVID-19 pandemic to geopolitical conflicts, underscore the urgent need for enhanced liquidity preparedness for margin and collateral. Non-bank financial institutions (NBFIs), or the “buyside,” face significant challenges in this area, often lacking the necessary tools and resources.

This article focuses on liquidity preparedness for margin and collateral management, emphasizing three fundamental tenets: enhanced transparency, rigorous stress testing, and a unified liquidity view. Recent regulatory developments stress the importance of these strategies in improving financial stability.

In September 2022, the Basel Committee on Banking Supervision (BCBS), the BIS  Committee on Payments and Market Infrastructures (CPMI), and the International Organization of Securities Commissions (IOSCO) published the “Review of Margining Practices,” which concluded that additional work was needed on liquidity preparedness as it pertains to margin and collateral. Similarly, in the UK, the Bank of England (BoE) and the Financial Policy Committee (FPC) reached similar conclusions regarding UK pension funds, resulting in defined liquidity resiliency criteria for UK pension funds.

The latest phase in this ongoing regulatory push towards liquidity resilience within the NBFI sector is from the Financial Stability Board (FSB) in April 2024 and BCBS IOSCO in January 2024, who go one step further in defining the best practices for the buyside by outlining their high-level recommendations:

• In January 2024, BCBS called for additional transparency in margin across CCPs and FCMs, resulting in 10 policy recommendations that would accomplish this aim.

• In their April 2024 consultation report, the FSB highlighted weaknesses in liquidity risk management across the buyside, particularly regarding margin requirements and collateral calls. They also set out eight policy recommendations from their analysis.

These announcements highlight the priority and increased oversight of regulators for improving transparency and understanding of margin and collateral requirements within the buyside, with the overall aim of significant improvements in liquidity resilience.

1. Enhanced Transparency 

One of the key themes outlined across these reports, particularly in BCBS’s document, was the desire to increase transparency for end customers on how CCP margin is calculated.

This increased transparency pertains to margin requirements under current market conditions and a transparent view of how margin requirements may change in adverse or stressed markets.

The BCBS report broadly sees two routes for achieving these aims.

• Disclosure of IM Models: CCPs should provide more detailed information about their Initial Margin (IM) models, including the methodologies, key parameters, and assumptions used in calculating IM.

• Regular Updates: CCPs should update disclosures regularly to reflect model changes or significant market conditions shifts.

2. Stress Testing

While the initial aim of increasing transparency is to improve the predictability of potential margin changes for the buyside, the regulators have also recognized the critical need for the impact of changes to market conditions to be equally well understood by all users.

As has been shown repeatedly, the nature and characteristics of individual market stress events can vary from past events. For this reason, CCPs should conduct regular stress testing and backtesting of their IM models to ensure they remain effective and responsive under different market scenarios.

However, it is becoming clear that buy-side firms also need access to tools to model their portfolios and understand their liquidity resilience in the context of their trading strategy and portfolio composition. 

Given the importance of Stress Testing as a margin and collateral management tool, we will dedicate our follow-up article to this topic.

3. Combining Margin and Collateral into a single liquidity view

The LDI crisis in the UK highlighted that although margin transparency and stress testing of margin are essential, the impact on the broader financial system from stress events is not limited to just a need to find additional assets to post as collateral.

Only by adding to the equation the effect on collateral from market stress can a firm see a holistic view of liquidity risks across its portfolio. By combining the collateral asset and margin liability sides of the liquidity equation when performing a stress test, a firm can truly understand where it stands on the target of full liquidity resilience.

These three core themes are consistent with recent global regulatory updates and reflect an emerging new market standard approach to ensuring liquidity resilience.

In our next article, we will discuss the impact of these elements on both the buyside community and the sell-side firms that provide clearing and prime brokerage services and their role in ensuring liquidity resilience across financial markets.