Uncleared Margin Rules and ISDA SIMM

The Uncleared Margin Rules (UMR) are a set of international regulatory requirements, developed by the Basel Committee on Banking Supervision (BCBS) and the International Organization of Securities Commissions (IOSCO), requiring that bilateral OTC derivatives counterparties exchange initial margin (IM) on their uncleared trades. The rules were designed to reduce systemic risk in the uncleared derivatives market by ensuring that the potential future exposure of a bilateral portfolio is collateralised — just as it is in the centrally cleared market.

UMR applies only to in-scope entities — those whose aggregate non-centrally cleared derivatives notional exceeds defined thresholds. But "only" is relative: at full implementation, UMR captures thousands of market participants worldwide, including many asset managers, pension funds, and corporates that had never previously been required to post initial margin bilaterally.

UMR was implemented in six phases globally, with each phase bringing a new group of counterparties into scope as the AANA (Aggregate Average Notional Amount) threshold was reduced:

• Phase 1 (September 2016): entities with AANA above €3 trillion (or equivalent). The largest global dealer banks.
• Phase 2 (September 2017): AANA above €2.25 trillion. The next tier of global dealers and very large buy-side institutions.
• Phase 3 (September 2018): AANA above €1.5 trillion.
• Phase 4 (September 2019): AANA above €0.75 trillion.
• Phase 5 (September 2021, delayed from 2020 due to COVID): AANA above €50 billion. This phase captured a much larger population — hundreds of mid-sized asset managers, pension funds, and regional banks globally.
• Phase 6 (September 2022): AANA above €8 billion (approximately). This was the most operationally disruptive phase, bringing in thousands of additional entities — including many smaller buy-side participants — who had very limited experience with bilateral IM processes.

The AANA threshold is calculated over a three-month observation period (typically March, April, May) each year. An entity that exceeds the threshold in one year may fall below it in a subsequent year if its derivatives portfolio shrinks, potentially exiting the IM exchange requirement. However, once an entity enters Phase 5 or Phase 6, it typically remains in scope.

UMR applies to "covered entities" — financial counterparties and, in some jurisdictions, non-financial counterparties above defined thresholds — when trading with other covered entities. The key in-scope entity types are:

• Dealer banks (all major global banks)
• Large asset managers (if AANA exceeds the threshold)
• Pension funds (subject to jurisdiction-specific exemptions)
• Insurance companies
• Hedge funds (typically classified as financial counterparties)

Importantly, centrally cleared trades do not count towards the AANA calculation. Only uncleared bilateral derivatives are in scope. This creates an incentive — where products are clearable — to clear them centrally rather than trading bilaterally.

There is also a threshold below which the bilateral IM exchange is not required even between two in-scope entities: the MTA/threshold framework allows parties not to exchange IM if the calculated IM amount is below €50 million (the "IM threshold" under the BCBS/IOSCO framework, though individual jurisdictions may use different amounts).

There are two approaches to calculating the bilateral IM amount under UMR:

The Standardised Approach (Schedule / Grid). This is a simplified, table-based approach where IM is calculated as a fixed percentage of notional, based on the asset class and maturity of the derivative. The percentages (ranging from 1% to 15% of notional) are set by the regulators and are deliberately conservative — they are designed to err on the high side to ensure adequate coverage. The Schedule approach is simple to implement but typically produces much higher IM requirements than a model-based approach because it takes no account of portfolio netting or diversification.

ISDA SIMM (Standard Initial Margin Model). ISDA SIMM is a sensitivity-based risk model developed by ISDA to provide a standardised, transparent, and industry-accepted approach to bilateral IM calculation. SIMM calculates IM from the portfolio's risk sensitivities (delta, vega, and curvature) across multiple risk factors and asset classes, then applies correlation and diversification benefits across risk buckets.

SIMM produces lower IM requirements than the Schedule approach (typically 20-40% lower for diversified portfolios) but requires more sophisticated implementation — both parties must calculate sensitivities consistently, agree on the SIMM version being used, and resolve any disputes in their respective SIMM calculations.

ISDA governs the SIMM model and publishes annual calibrations of the model parameters. Both parties must use the same version of SIMM and the same calibration to achieve consistent results. Parties can also use approved internal models in some jurisdictions, subject to regulatory approval.

One of the most operationally demanding aspects of UMR is the segregation requirement. Bilateral IM must be held at an independent third-party custodian — it cannot simply be transferred to the counterparty (as VM is). This is a fundamental difference from the pre-UMR world, where bilateral collateral was typically transferred outright under the ISDA CSA (title transfer).

Segregation means:

• The pledging party's IM is held at a custodian in the name of the pledging party (not the receiving party)
• The receiving party has a security interest in the collateral — it can access it in the event of a counterparty default — but does not own it outright
• The IM cannot be rehypothecated (reused) by the receiving party
• A triparty arrangement is typically used: the pledging party and receiving party both have accounts at the same custodian, and the IM is segregated in a dedicated account

Establishing the legal and operational infrastructure for segregated IM — new CSA documentation (the ISDA 2018 Credit Support Annex for Initial Margin), new custodian relationships, new account structures — was a significant implementation challenge, particularly for Phase 5 and 6 entities that had never done this before.

UMR implementation for Phase 5 and 6 entities proved to be one of the most operationally demanding regulatory changes in recent memory. Entities entering Phase 5 in September 2021 needed to:

• Calculate their AANA across all legal entities in the group
• Determine which counterparty relationships would exceed the €50 million IM threshold and therefore require IM exchange
• Negotiate new ISDA 2018 CSA (IM) documentation with each in-scope counterparty
• Establish custodian accounts for segregated IM at one or more triparty agents
• Implement SIMM calculation capabilities (either in-house or via a vendor such as AcadiaSoft)
• Establish operational workflows for daily IM call calculation, agreement, and settlement

The lead time required for all of this — particularly the ISDA documentation negotiation, which can take 6-12 months per counterparty — meant that many Phase 5 and 6 entities were working to very compressed timelines, and some required regulatory forbearance or temporary exemptions while their programmes completed.