Mitigating the procyclicality of margins and haircuts in derivatives markets and securities financing transactions

ECB
By January 17, 2020 09:01

Mitigating the procyclicality of margins and haircuts in derivatives markets and securities financing transactions

By ESRB Expert Group on the Macroprudential Use of Margins and Haircuts

This report considers systemic risks arising from the procyclicality associated with margin and haircut practices and sets out possible policy options to address these. Post-crisis regulatory reforms have resulted in the majority of derivatives being centrally cleared or subject to bilateral collateral requirements. These include the exchange of variation margins, the posting of initial margins and the application of collateral haircuts. These regulatory reforms have made the financial system safer by preventing the build-up of unsecured exposures, thereby reducing counterparty credit risk and the risk of contagion in the event of default. A side effect of the greater use of collateral is that the systemic risk profile has seen a transformation of credit risk into liquidity risk, as market participants need to be able to provide high-quality collateral at short notice in response to movements in market prices. In particular, if securities financing transaction (SFT) markets become impaired during times of market stress, counterparties may not be able to rely on them to source the right collateral to meet margin calls for other transactions at short notice. In such cases, collateral requirements, including margin and haircut practices, may lead to or amplify procyclical developments by channelling liquidity strains through the financial system. A previous report (ESRB, 2017) includes a comprehensive analysis of these risks and a broad list of potential macroprudential tools to address them. This report revisits and extends the findings in ESRB (2017) through data analysis and market intelligence on the functioning of the derivatives and SFT markets. It reduces the broad list of potential tools presented in ESRB (2017) to a narrower set of policy options for further work.

ECB
By January 17, 2020 09:01

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