The SIMM methodology, one of the two primary algorithms used by firms subject to UMR, is usually updated annually at the end of each year. This year, however, ISDA decided to add a mid-year re-paramaterisation – coming up in just two days’ time – and firms (especially those trading fixed income) need to be aware that their margin requirements are likely to rise.
The surprise re-paramaterisation, which was only announced on 5 May, is set to go live on 15 July – meaning that firms will need to be ready to calculate their initial margin for close of business on Friday, 14 July using the new measure in order to prepare for the first day for exchange of initial margin calculated by SIMM version 2.5A on Monday, 17 July.
The ISDA Standard Initial Margin Model (SIMM) is one of two main algorithms used by firms subject to the Uncleared Margin Rules (UMR), introduced by Basel III following the financial crisis in order to reduce the risk of OTC derivatives exposure by ensuring that collateral is available to offset losses caused by the default of a derivatives counterparty. The UMR framework has been implemented across multiple jurrisdictions under multiple regimes, with the International Swaps and Derivatives Assocation (ISDA) SIMM acting as the most commonly used model for calculating initial margin.
A parametric, sensitivities-based VAR model calibrated to market data over historical stress periods, the last update to SIMM at the end of 2022, following the final rollout of UMR phase 6, concentrated on commodity products – thus having a significant impact on margin requirements for some portfolios.
Notably however, this latest mid-year update is focused on fixed income products – meaning that the firms who trade them need to be aware that their margin requirements are likely to increase.
“It makes sense that ISDA is focusing on fixed income products, given the volatility that has been experienced across certain pockets of these markets over the last year,” noted Jo Burnham, risk & margining subject matter expert at OpenGamma, speaking to BEST EXECUTION. “Firms who trade these need to be aware that their margin is likely to increase.”
The new 2.5A version includes updates based on the off-cycle recalibration of only the main interest rate delta risk weights and testing of the methodology as part of industry quarterly monitoring exercise.
Gemma Bailey, business manager at OSTTRA triCalculate, explained to BEST EXECUTION what steps they have taken to help their clients meet the new requirements: “It is of paramount importance for financial institutions to have full transparency into their IM calculation through this off-cycle recalibration, and indeed any further on-cycle or off-cycle recalibrations. We have offered our clients recalculations based on the new SIMM model 2.5A to assess its impacts on their initial margin requirements. In addition to adding pre-deal checking to our IM calculator, we are in the process of implementing stress testing so that clients can see the “what-if” impact of market data moves. Comparison of results between model versions are another example of how this type of analysis can help ensure clients are prepared for any changes to their initial margin calculations.”
It will also be interesting to see if, going forward, ISDA continues to make more regular bi-annual updates to SIMM. This would bring it in line with clearing counterparty (CCP) methodologies, where for scenario-based models like SPAN (a margin algorithm often used for ETD products) parameters are changed on a regular basis, while VaR-based models adjust daily based on new prices and volatilities.
“This mid-year calibration reinforces the need for market participants to optimise counterparty risk to reduce margin exposures specifically for rates exposures as the risk weights increase for ‘regular volatility currencies’ with the updates to SIMM, this includes risk beyond 1 year in the most liquid currencies except JPY,” Erik Petri, head of OSTTRA triReduce & triBalance, told BEST EXECUTION.
“We expect the industry to continue to optimise both cleared and non-cleared risk, with a view to reducing the size of margin calls and the associated funding costs. The changes implemented with SIMM 2.5 may also push firms in the later IM phases over the GBP50mn threshold and increase demand for optimisation.”
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