ISDA SIMM for non-cleared options

By Elias Bataire, Consultant, Valuation services

For calculating the IM, the ISDA standard initial margin model (SIMM) has been developed for non-cleared derivatives as settled by the BCBS-IOSCO guidelines. The aim of this methodology is to increase the efficiency through netting exposures and the reconciliation process to resolve differences in IM values. The model applies a sensitivity-based calculation within four product types: equity, interest rates and foreign exchange, credit, and commodities. Sensitivities are used as inputs into aggregation formulae tailored to identify hedging and diversification benefits of trades according to specific risk factors and matrices. 

The collection of IM is generally consistent for the scope of non-cleared derivatives across the principal jurisdictions in Europe, US, and Asia. However, a specific jurisdiction can have some exclusions: e.g., equity options are excluded until January 2021 in the EU. When the netting set consists of options under the EU jurisdiction, “the option seller should be able to choose not to collect initial or variation margins for these types of OTC derivatives as long as the option seller is not exposed to any credit risk. The counterparty paying the premium (‘option buyer’) should however collect both initial and variation margins”. Thereby, 

even if the option seller does not face any potential future exposure with the premium paid, the option buyer is still required to post the IM and VM, unless he is able to isolate this trade from other potential future exposures with the option seller. 

To achieve this, the option buyer with zero counterparty risk could use the practical solution to enter into specific CSA to isolate the option from other trades following an explicit agreement with the option seller willing not to collect the IM and VM. Nevertheless, this practice leads to extra costs for the market participants and can be avoided if the option buyer posts the IM despite the fact that he has no counterparty risk.

In the case of an option buyer who must still post the IM alongside the option seller, an asymmetry in the amount posted and collected will arise. Typical discrepancies due to the premium and calculation currency being laid aside, differences will appear from the computation of the curvature margin component of the ISDA SIMM methodology