By 1st December 2015, BCBS-IOSCO rules mean that all eligible financial and non-financial counterparties must be able to exchange bilateral Variation Margin (VM) and Initial Margin (IM) with their OTC derivatives counterparties. The consequences of this extend far beyond methodology, requiring a re-evaluation of the whole end to end workflow.

1. Bilateral Margining: Consequences
Beyond Methodology
www.catalyst.co.uk
1
1 FC and NFC in EMIR (Article 11(3)) is defined as Financial Counterparty and Non-Financial Counterparty.
How to make the right choice, understand the impact and navigate new complexity
September 2014
By 1st December 2015, BCBS-IOSCO rules mean that all eligible financial and non-financial counterparties1
must be able to exchange bilateral Variation Margin (VM) and Initial Margin (IM) with their OTC derivatives
counterparties. While counterparties often collateralise VM, it is not always exchanged as robustly as the
regulations will now require and few counterparties have routinely margined each other for either risk or IM.
These margining regulations are therefore a major event, requiring banks to move both cash and non-cash
collateral on an unprecedented volume and scale, more frequently and with more controls than ever before.
The scale of change is potentially huge. Bilateral margining touches numerous aspects of the workflow, not
least initial trade confirmations and sensitivity matching, margining, dispute resolution and physical collateral
instructions.
This paper focuses on the options around IM models, as this is where the need to make the right choice is
most acute and where the impact of change is most visible. We outline the key regulatory context against
which to make crucial decisions and offer an overview of the advantages and disadvantages of each option.
We also discuss the most significant consequence of choice: complexity. Given that market participants will
now be able to define their own regime, increasingly varied and complex margin models are likely to
proliferate. These will, in turn, need to be validated and sustained by banks and regulators well into the
foreseeable future. Crucially, this means it will be essential for banks to be able to replicate each other’s
methodologies, in order to price derivatives and reconcile margins correctly. Transparency and
sustainability will be essential.
Overall, we believe that the impact of this next new complexity between counterparties cannot be under-
estimated. Our advice is to respond to these wide-reaching changes with a strategic approach, clear
thinking and to re-engineer, not simply adjust, your existing process to secure the most sustainable, cost
effective solution for the future of your business.

2. © Catalyst Development Ltd 2
How did we get here?
Following EMIR’s pronouncement that
participants in the OTC derivative markets
must develop all necessary risk and collateral
management frameworks to support their
trading activity2, BCBS & IOSCO have
developed the “Margin Requirements for non-
centrally cleared derivatives3”
The core elements of this BCBS & IOSCO
document are summarised below.
Figure 1 Key elements of the BCBS IOSCO
Minimum Standards
The consultation period on the draft
Regulatory Technical Standards closed on
14th July 2014 and the outcomes are not yet
known. But what is clear is that ‘covered
entities’ (ie entities within the scope of the
2
Regulation (EU) No 648/2012 …‘shall have risk-
management procedures that require the timely,
accurate and appropriately segregated exchange of
collateral with respect to OTC derivative contracts’
http://eurlex.europa.eu/LexUriServ/LexUriServ.do?ur
i=OJ:L:2012:201:0001:0059:EN:PDF
regulations) will be required to post both
Variation Margin and Initial Margin on a two-
way basis in accordance with the timeframe
below:
 1 Dec 2015: expect Variation Margin
requirements to apply;
 1 Dec 2015: expect Initial Margin to be
mandatory for top 30 – 60 banks (by OTC
notional);
 1 Dec 2015 – 1 Dec 2019: expect Initial
Margin to be phased-in by participant
class.
While the tightening of Variation Margin
requirements is expected to present relatively
few challenges, firms must now consider how
best to calculate Initial Margin.
3
Margin requirements for non-centrally cleared
derivatives (Sept 2013)
http://www.bis.org/publ/bcbs261.htm
BCBS IOSCO
Margin
requirements
for non-centrally
cleared derivatives
Key Elements of BCBS IOSCO Minimum Standards
Product Scope
--------------------
All uncleared
derivatives except
physically settled FX
Entity Scope
--------------------
Financial firms and
systemically
important non-
financial entities
IM & VM minimum
amounts &
methodologies
--------------------
Model- and/or
schedule-based IM,
minimum standards
re. exchange of VM
Eligible Collateral
--------------------
Cash, Government
bonds, central bank
securities, High-
quality covered
bonds etc.
IM Treatment
--------------------
Rehypothecation
possible, but subject
to conditions
Affiliate
Transactions
--------------------
IM & VM
requirements
between affiliates to
be determined by
local supervisors
Cross Border
Transactions
--------------------
Regulatory regimes
to achieve
maximum possible
harmonisation
Phase-In
--------------------
VM requirements
apply on all new
contracts from 1
December 2015 and
IM requirements
phased-in from 1st
Dec 2015

3. © Catalyst Development Ltd 3
In our opinion, that brings three main choices:
 rely on the BCBS and IOSCO initial
margin schedule4
;
 develop your own IM model in-house;
 or collaborate with other firms to develop
a common solution.
Below are the key considerations we advise
you to take into account to arrive at the best
solution for your particular circumstances.
Sharpen up your VM regime
Irrespective of market participants’ previous
VM policies, regulators have now asked them
to sharpen their procedures by re-assessing
such mechanisms as call frequencies, legally
enforceable netting agreements and dispute
resolution procedures.
We believe that the regulators’ call to
action offers a significant opportunity to
review your collateral management
systems and to make sure you have the
operational capability to support an
evolved collateral model.
In doing so, you should ensure your target VM
infrastructure has these key features:
 a rationalised and reduced number of
collateral management systems;
 efficient legal agreement management,
with CSAs stored digitally and centrally
and codified and electronic CSA data to
promote legal certainty;
 automated collateral management
infrastructure, with electronic margin
messaging to facilitate the call process;
 optimised and re-hypothecated control
mechanisms;
 a high degree of transparency that helps
to drive the substitution process, with
traceable firm-wide positions and with
CSA details helping to deliver relevant
4
‘Margin requirements for non-centrally cleared
derivatives’ Appendix A
CSA/ISDA information to desks for pricing
and also with data transparency helping to
drive regulatory reporting;
 the ability to support increased TriParty
involvement to cope with the increasing
volume of collateral instructions and
counterparties.
Plan for new IM infrastructure
Before the regulators envisaged the bilateral
margining requirements, the only near
equivalent to IM was an independent amount
(IA) and even then IAs would only generally
be applied to a small sub-set of clients.
Banks will now no longer have a choice
over whether (or how) they levy IM
amounts. The regulations will also require
that VM and IM must be charged to all
eligible counterparties on a more frequent
basis, even where they were already
previously charged.
Choose the best approach to IM
simulation
This forms the substantive part of the
decisions and actions you need to take.
In our opinion, there are, again, three main
choices here. Each deserves consideration
and discussion against your own particular
criteria and business context.
These are what we believe to be the main
advantages and disadvantages of each.
OPTION 1:
Rely on the BCBS and IOSCO IM schedule
If you decide not to develop your own in-
house IM methodologies (or want to rely on
your counterparties’ models), you have the
option of using an IM schedule developed by
BCBS-IOSCO (see overleaf).

4. © Catalyst Development Ltd 4
Standardised Initial Margin Schedule5
Asset class
Initial margin
requirement (% of
notional exposure)
Credit: 0–2 year
duration
2
Credit: 2–5 year
duration
5
Credit 5+ year
duration
10
Commodity 15
Equity 15
Foreign exchange 6
Interest rate: 0–2
year duration
1
Interest rate: 2–5
year duration
2
Interest rate: 5+ year
duration
4
Other 15
This approach is relatively simple and should
require less time and effort to implement than
the other choices available to you.
However, any savings you might make in
terms of implementation costs should be
carefully compared to the potential excess
margins that accepting a ‘one-size-fits-all’
approach may entail. This is because, given
their all-encompassing nature, IM charges are
likely to be highly conservative and hence
considerably more costly than those under
tailored models – an issue highlighted, albeit
in a different context – in reports of the Bank
of England’s recent calls for a relaxation of
capital rules for smaller firms6.
OPTION 2:
Develop your own IM model in-house
If your risk management function decides to
develop an in-house IM model, you will need
to check whether this will:
5
Margin requirements for non-centrally cleared
derivatives’, Appendix A
http://www.bis.org/publ/bcbs261.pdf
6
http://www.telegraph.co.uk/finance/newsbysector/
a) Adopt the standardised approach
The advantages of this choice include:
 securing a more capital efficient solution
than the published schedule;
 building on strong foundations: ISDA has
published a paper proposing the Standard
Initial Margin Model (SIMM)7
which the
regulators and the industry are currently
working to refine;
 In addition, if you decide to implement the
model as-is, you should encounter a less
intensive and quicker change process.
However, some change will still be
required to validate the model and you will
also need to determine how risk and
collateral systems and processes need to
be modified to support the new
methodology.
The disadvantages include:
 losing the opportunity to save costs;
 the devil is in the detail, but the more
standardized the approach, potentially the
less comparative advantage in risk and
modelling the bank can bring to bear.
b) Develop your own approach
A proprietary approach will rely on leveraging
your in-house resource, particularly your
quants and risk management teams to build
your own IM model.
The advantages include:
 Long term savings: once you have
recouped the costs of the build process,
these will derive from an internal
methodology tailored to your business and
to your risk and pricing strengths.
 Competitive pricing: if you believe you
have an advantage in the sophistication of
your risk methods, you can present a
lower total cost of trading, in the form of a
narrower spread, to counterparties.
banksandfinance/10963748/Let-small-banks-lend-
more-says-Bank-of-England.html
7
www2.isda.org

5. © Catalyst Development Ltd 5
The disadvantages include:
 Substantial lead-time: time is already of
the essence, with less than 18 months in
which to develop IM methodologies and
make sure they pass through regulatory
review. Realistically, models will require
several iterations before they gain
regulatory approval.
 Key man/function dependencies: you
will create project dependencies by
needing to draw more heavily on trading
desks and risk management teams. You
must be able to factor-in their time and
costs and accurately re-charge budgets to
the right internal cost centre.
 ‘More change’ fatigue: you will need to
articulate a clear rationale and benefit
statement for this change and align the
change process with any wider
programmes, taking account of
interdependencies and overlaps of policy,
personnel and timing.
 Insularity: where banks perceive a
comparative advantage in risk and
margining, it can make them miss benefits
elsewhere in the bilateral margining
process, particularly where these derive
from other solutions such as matching,
dispute resolution, collateral instruction or
regulatory overheads.
c) Customise by business line
The regulations allow for banks to employ
different approaches for different classes of
derivatives: a bank could use an internal
model for one class and the published
schedule for another. The advantages of this
approach are:
 retaining comparative advantage in
products where you lead;
 avoiding expensive internal
implementations for products which are
low volume or non-core;
 implementing the ISDA SIMM for high
volume, low margin products, where
comparative advantage is moot;
 prioritising model development in order
to achieve the compliance date. Banks
could choose to develop internal models
for key products first and exist on the
published schedule for non-core products
until further efforts can be prioritized.
The disadvantages are:
 Managing complexity: IM management
approaches will need to be clearly defined
and to take into account the need to
consolidate across group structures and
varied product workflows, adding several
layers of complexity.
 Future proofing: proliferating models
within your own organisation increases
the difficulty of managing them as a
portfolio for future change or compliance.
 Regulatory overhead: regulators will not
tolerate ‘cherry-picking’ - or even its
perception - between models.
Transparency & sustainability are key
Whichever choice you make, IM
methodologies will now inevitably vary from
firm to firm. Indeed, since the industry has
given market participants the ability to define
their own regime, varied and complex IM
models are likely to proliferate.
All these new models will need to be
understood by market participants so that
they can price against individual
counterparties; validated by banks and
regulators and sustained over the long
term.
For example, if Bank A chooses to simulate
margin requirements using a proprietary
model, all their counterparty firms would need
to have the ability to replicate their models,
both when calculating or validating margin
calls and when pricing the cost of margin pre-
trade.
If this new complexity is to avoid causing
multiple (even if unintended) additional issues,
individual change teams within firms will need
to ensure their models are sufficiently
transparent and well-resourced for other firms
- and indeed for the regulators themselves –
to continue to understand the full range of
models in operation. This requires a
considerable commitment of resource,
which individual banks, as well as
regulators, must be able to sustain long-
term.

6. © Catalyst Development Ltd 6
OPTION 3:
Collaborate to develop a common
methodology
As the need to understand and reduce the
total costs of trading and maximize capital
efficiency continues to bite, we are seeing
increasing instances of banks collaborating
over non-commercially competitive solutions
to address complex, shared problems,
especially in post-trade and infrastructure.
Depending on your firm’s attitude to this
relatively innovative – but potentially
commercially sensible – way of thinking, a
consortium approach to developing a bilateral
margining solution or centralised “utility” could
offer a solution which is agreed by all parties
and then potentially outsourced to a third-
party provider or embedded within each
bank’s risk management infrastructure.
The advantages of this approach include:
 Potential reduction of disputes: the
assumption is that, if firms all use the
same, standardized IM model, possibly
including trade or sensitivity matching, this
will reduce the likelihood of disputes.
 Potential reduction of capital charges:
if we assume that a common methodology
reduces disputes, it should also reduce
capital charges. Indeed Article 285 of the
Capital Requirements regulation actively
incentivises banks to have robust dispute
resolution processes in place, by applying
increased capital charges to any firms
who do not resolve disputes in a timely
fashion:
‘If an institution has been involved in
more than two margin call disputes on
a particular netting set over the
immediately preceding two quarters
that have lasted longer than the
applicable margin period of risk under
paragraphs 2 and 3, the institution
shall use a margin period of risk that is
at least double the period specified in
paragraphs 2 and 3 for that netting set
for the subsequent two quarters.’ 8
8
https://www.eba.europa.eu/regulation-and-
policy/single-rulebook/interactive-single-rulebook/-
/interactive-single-rulebook/article-id/1870
 Harnessing innovation: market
discussion of the best margin
methodology inevitably leads to
consideration of what offers the greatest
capital efficiency. This in turn prompts
discussion of the possibility of ‘margin
sharing’. The basic premise9
is that, if the
IM requirement was EUR 60MM, then
instead of both parties exchanging
EUR60MM, they could both simply post
30MM to a third-party account.
 A stronger team to engage with
regulators: where a number of banks
have worked together to discuss and
resolve non-competitive issues before
entering the regulatory process, this
should form a strong basis from which to
articulate and achieve a positive
engagement with regulators.
 Solving for more than just
methodology: it’s easy to get lost in
methodological detail when in fact there is
significant benefit to be achieved from
other areas of the workflow. There is real
potential for a new consortium initiative to
produce a solution that links individually
strong, but disparate, elements of the
workflow such as matching, dispute
resolution and collateral instruction, as
well as margin methodology.
 Maximising the impact of other
industry initiatives: considerable thought
has already been given to how better
trade matching could reduce margin call-
disputes. Banks have long realized the
benefits of stringent reconciliation
processes and of using industry solutions
to monitor and control trade populations.
Many of the separate elements of a
margining utility already exist (such as
matching, reconciliations, collateral
messaging) in the form of vended
products and services which could be
linked together to offer the end-to-end
bilateral margining workflow at a utility.
Discrepancies could still occur further up
the trade-flow process and these will still
need to be addressed, whether or not
firms opt to use an industry utility to
calculate margins.
9
http://www.risk.net/risk-
magazine/feature/2335760/dealers-push-margin-
sharing-as-answer-to-collateral-crunch

7. © Catalyst Development Ltd 7
However, while a strong concept, this
approach remains some way off from actual
regulatory approval and industry
implementation and the key disadvantage is
simple:
 No magic bullet: the development of a
common methodology is not a panacea
for dispute resolution. Other solutions are
under investigation to improve
weaknesses in the margin call and
collateral management chain, highlighted
during the financial crisis and in our
opinion, these remain vital.
Conclusion
In summary:
 All options present opportunities.
Both change and choice bring
consequences and one-size-fits-all is
potentially expensive in terms of
margin levels.
 While the first wave of regulations
may not take effect for 18 months,
the volume of preparation required
from an operational, risk and legal
perspective is substantial.
 In particular, firms need to prepare
not just for 1st
December 2015, but
for the wider consequences that date
brings for years to come, as the
population of counterparties eligible
under the regulation increases.
 Despite some industry commentators
and bodies recently pushing for a stay
of execution, we strongly believe that
the current deadlines are here to stay.
Bilateral margining is not comparable
to, for instance, OTC client clearing,
because unlike client clearing, the
bilateral margining deadlines were
announced with significant notice,
clear rules and most importantly,
transparent phasing and eligibility
criteria. We think it unlikely that the
regulators would accept delay and it
would be a very high risk strategy
indeed to rely on a stay of execution.
 Indeed by contrast, we believe there
are palpable opportunities on offer
for banks to benefit from this
regulation, if they are able and willing
to apply strategic thinking rather
adopting a reactive ‘compliance’
approach.
Your first step should undoubtedly be to
assess any gaps in your existing risk and
operational policies and ensure you have the
resources and budget in place to address
them. But you should do that review in the
round, considering all the workflow elements
not just the margining methodology: any sub-
optimal analysis at this early stage is likely to
embed risk and preclude significant future
margin or cost savings.
Before you go straight to the ‘right answer’
and fix on what you believe to be the best IM
model for your business, setting in motion a
process with its own momentum to deliver it,
our advice is to step back and look more
widely at the new market context and future
OTC infrastructure landscape (more reporting,
more compression, more messaging
aggregation and faster collateral moves) in
which any new model must operate.
You should also think about regulatory
alignment across jurisdictions – since
September 4th 2014, EU and US draft rules
have both published and while they are
consistent at a high level, there are gaps of
which you should be aware, particularly in
terms of the differing requirements around
historic data and stress periods and the EU
approach to non-EU end-user counterparties.
Only through a thorough consideration of all
these issues will you be able to make a valid
assessment of the advantages and
disadvantages of the choices available and
understand fully the longer term commitments
of the decisions you need to make today.
How can we help?
Catalyst are leading experts in OTC derivative
risk and regulation. We help clients both
manage the uncertainty inherent in fluid rules
and optimise their investment. We can ensure
your bilateral margining programme achieves
not only regulatory compliance, but also
significant economic benefit.

8. Meet our authors
stephenloosley@catalyst.co.uk
Disclaimer: Comments in this presentation on are based on Catalyst's understanding of the global regulatory landscape as of September 2014.
This document is neither intended to be comprehensive, nor to provide legal or accounting advice.
Catalyst Development Ltd, 167 Fleet Street, London, EC4A 2EA
T +44 (0) 870 901 4155 F +44 (0) 871 433 8876 www.catalyst.co.uk
corinnaathanasopoulos@catalyst.co.uk
About Catalyst
We are experts in optimising our clients’ balance sheet, reducing the total cost of trading and
enabling regulatory compliance. We work in joint teams with our clients, combining our experience
in financial markets and programme execution to deliver results. We provide honest guidance to help
you succeed. We are Catalysts for enduring excellence.
Christian Lee
Christian leads Catalyst’s
Clearing, Risk and
Regulatory team and has
over 25 years’
experience in financial
markets. He began his
career as a Chartered
Accountant and, as Head
of Risk at LCH, managed
the Lehman’s default: the
biggest market-shaping
event of recent times.
Christian is
acknowledged as a
world-leading authority
on risk, with in-depth
specialist knowledge of
OTC clearing and
experience in a variety of
risk management roles
and specialisms,
including market and
credit risk, financial
markets, middle office
and regulatory matters.
Stephen Loosley
Stephen is a leading expert
in OTC clearing. Having
originally joined LCH
Clearnet as an analyst, he
left as Head of SwapClear’s
middle office, running risk
and operations for $300tr of
IRS swaps across 50 banks.
Stephen leads Catalyst’s
international delivery teams
in specialist OTC clearing,
risk and regulatory projects.
Corinna Athanasopoulos
Corinna has extensive
experience as a business
analyst and has worked on a
large number of regulatory
and clearing initiatives at
global investment banks and
exchanges.
Corinna possesses strong
knowledge of OTC
derivatives and central
clearing across all phases of
project lifecycles, including
requirements gathering and
analysis, stakeholder
management, authoring of
business cases, UAT, system
architecture documentation
and vendor reviews.
christianlee@catalyst.co.uk