The Financial Stability Board (FSB) has issued a final report on liquidity preparedness for margin and collateral calls. The document forms a part of the organisation’s work programme on non-bank financial institutions (NBFIs). In it, the FSB sets out eight policy recommendations to enhance the liquidity preparedness of NBFIs in times of margin and collateral calls in centrally and non-centrally cleared derivatives and securities markets.
The FSB’s work programme is a follow-up of the review of margining practices jointly conducted in 2022 by the Basel Committee on Banking Supervision (BCBS), the Committee on Payments and Market Infrastructure (CPMI), and the International Organization of Securities Commissions (IOSCO). This report collects findings from a survey and FSB’s analysis of “recent incidents of liquidity stress”, including the March 2020 market turmoil, the Archegos failure in March 2021, and the commodities market turmoil in 2022.
Necessary evil
FSB observes that “whilst margin and collateral calls are a necessary protection against counterparty risk, they can also amplify the demand for liquidity by market participants if they are unexpected in times of stress and affect a large enough part of the market. The increase in such calls can impact market participants differently depending on the size of positions and level of liquidity preparedness”.
To mitigate this, the FSB has set out eight policy recommendations covering three areas: liquidity risk management practices and governance; liquidity stress testing and scenario design; and collateral management practices.
Best practices
Falling under the area of liquidity risk management practices and governance, recommendation one suggests that “market participants should incorporate the assessment of liquidity risks arising from margin and collateral calls in their liquidity risk management and governance frameworks”.
Recommendation five, under the area of liquidity stress testing and scenario design, says that “robust stress testing should analyse a range of extreme but plausible liquidity stresses caused by changes in margin and collateral calls, as well as market participants’ overall liquidity position”.
Recommendation eight, under collateral management practices, encourages market participants to “have active, transparent, and regular interactions with their counterparties and third-party service providers in collateralised transactions to ensure adequate operational resilience with respect to spikes in margin and collateral calls under stressed conditions”.
The FSB specifies that these recommendations are “intended to build on and complement rules and regulations for liquidity risk management and governance that already exist in many sectors and jurisdictions” and that they should be applied “proportionately to the underlying risks of different non-bank market participants”.
