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The Financial Stability Board (FSB) has proposed eight policy recommendations to enhance the liquidity preparedness of non-bank market participants for margin and collateral calls, in centrally and non-centrally cleared derivatives and securities markets.
Weaknesses in liquidity risk management and governance by some market participants, were found to be the key causes behind inadequate liquidity preparedness for margin and collateral calls, says the FSB.
The organisation presented the proposals through a consultation report, which highlights the need for policy adjustments to combat liquidity strains in the non-banking financial institution (NBFI) sector, arising from spikes in margin and collateral calls during times of market stress.
Recent examples of market stress include the March 2020 market turmoil during the pandemic; the collapse of Archegos; and the commodities market turmoil and stress in liability-driven investment (LDI) funds in 2022.
One of the recommendations sets out the need for establishing liquidity risk appetites for margin and collateral calls, as well as contingency funding plans to ensure liquidity needs can be met.
Another proposal calls for liquidity stress tests to cover a range of extreme but plausible scenarios, including both backward-looking and hypothetical.
The recommendations cover liquidity risk management and governance, stress testing and scenario design, and collateral management practices of non-bank market participants, focussing on liquidity risks arising from spikes in margin and collateral calls.
They apply to non-bank market participants that may face margin and collateral calls, including insurance companies, pension funds, hedge funds and family offices.
The report also highlights the need for financial intermediaries in bilateral transactions with non-financial entities, such as commodities traders, to consider assessing their liquidity preparedness for spikes in margin calls and collateral during times of stress.
This consultation forms part of the FSB’s work programme on enhancing the resilience of NBFIs. It follows up on the findings of a review of margining practices conducted in 2022 by the Bank for International Settlements’ (BCBS) Committee on Payments and Market Infrastructures (CPMI) and the International Organization of Securities Commissions (IOSCO).
The FSB has invited market participants to provide comments on the consultation report. Responses should be submitted through its online form by 18 June 2024.
