Executive summary

The over-the-counter (OTC) derivatives market highlighted the significant amount of leveraged, unmanaged risk undertaken by several financial institutions during the Global Financial Crisis in ~2008. They did so without maintaining or posting adequate margin between counterparties.

In March 2015, the Basel Committee on Banking Supervision (BCBS) and the International Organization of Securities Commissions (IOSCO) published the final policy framework that established the minimum standards for margin requirements for non-centrally cleared derivatives.

The BCBS and IOSCO had both agreed on the terms and implementation timeline of the framework, which was launched in September 2016 as Unclear Margin Rules (UMR). Since then, UMR has been implemented in a phased manner by the eligible financial institutions.

Further to this, the European Banking Authority (EBA) has been mandated to develop regulatory technical standards (RTS) to specify the supervisory procedures that would ensure initial and ongoing validation of the risk-management procedures covering exchange of margins for the financial institutions in European region.

The EBA released a draft of the RTS for validating Initial margin(IM) models on July 3, 2023. The draft RTS delineates the steps and methodology for IM model validation (IMMV).

In the design of IMMV, the EBA aims to harmonise the supervisory review of the IM model and has, thus, factored in the following:

• The variety of counterparties involved. On the one hand, there are banks with substantial exposure to OTC derivatives and a mature model approval process. On the other hand, there are numerous small market participants with low OTC exposure and a less rigorous model approval process. This leads to distinct validation approaches for each type of counterparty
• Validation of IM models when a common model is adopted as the industry benchmark (e.g., ISDA SIMM), and how the competent authorities can avoid duplication of efforts
• Transition to this regulatory standard given the IM model is extensively used by members without supervisory approval in some cases