The call for margin
The world of finance relies heavily on derivatives transactions. Following the financial crisis of 2008, world leaders agreed that over-the-counter (OTC) derivatives needed more transparency and better tools to mitigate risk. This led to new regulations forcing market participants to exchange collateral. A key component of this is the requirement for Initial Margin (IM). Managing these complex transactions and regulatory requirements efficiently is where the Common Domain Model (CDM) comes in.
We at TradeHeader worked with FINOS to develop the CDM, which is a machine-readable and machine-executable data model designed to standardise how derivatives are traded and managed through their lifecycle. It provides a common representation for products, processes, and calculations. The launch of CDM 6 in January this year, marked an important milestone for the model. We welcome involvement from market participants in the project.
How Initial Margin is Calculated
There are two main methodologies for calculating initial margin for collateral posting:
- The International Swaps and Derivatives Association (ISDA) SIMM (Standard Initial Margin Model): Developed by ISDA, SIMM is a complex, risk-sensitive approach. It is primarily used by large institutions with advanced portfolios and takes into account netting and diversification benefits. SIMM calculation requires inputs known as ‘sensitivities’, which measure how the value (or price) of a derivative contract changes in response to a small change in a specific underlying market risk factor. A key element to bear in mind here is that calculating these sensitivities requires access to a pricing engine.
- Standardised Schedule Method: This method is simpler. It uses predefined margin rates based on asset class and duration. It's designed for smaller firms or those without advanced risk modeling tools and is appropriate for firms below a certain threshold of derivatives transactions volume. It provides a structured process based on predefined margin rates.
While SIMM is required for firms above a certain threshold, the Standardised Schedule method is crucial for smaller firms not yet required, or able to use SIMM. Importantly, even firms approaching the SIMM threshold can benefit from understanding and potentially using the Standardised Schedule to become familiar with initial margin concepts.
Initially, TradeHeader looked into the use of SIMM but found challenges. SIMM requires sensitivities to be calculated using a pricing engine, and truly complete open-source pricing engines are not readily available. They usually have a free open-source layer but a commercial license is required to get the full product coverage. Recognising the need for a freely available, standardised solution for the simpler method, TradeHeader decided to take a "step back" from SIMM and focus on the Standardised Schedule.
TradeHeader's Contribution and its Benefits
At the end of 2024, TradeHeader developed a common representation and open-source implementation of the Standardised Schedule method within CDM 6. This has been designed as a freely available and easy-to-use solution for firms to calculate initial margin using this method.
TradeHeader's contribution makes it significantly easier for firms to implement and understand standardised initial margin calculations. This is particularly useful for firms not yet required to use ISDA’s SIMM. It is a valuable tool for firms to get familiar with initial margin concepts in a practical, open-source environment.
Key advantages include enhanced accuracy and consistency in margin calculations, industry standardisation which reduces potential disputes and eases compliance, improved risk management by providing a structured approach to assessing risk and adjusting for exposures, and ultimately, contributing to strengthened market stability by fostering transparency in OTC derivatives trading.
Future Work
TradeHeader is continuing to enhance the Standardised Schedule implementation in CDM. Ongoing work includes providing mark-to-market functions for the standardised schedule. The goal is to have a set of functions that provide valuation calculations for different OTC derivative products based on current market prices.
Get involved, we’re here to help!
We welcome involvement from market participants in the project and value contributions to its further development.
Please contact TradeHeader for more information on this use of CDM 6 and how it can benefit your firm.
You can reach us via email at info@tradeheader.com.
For more detail on implementing the Standardised Schedule for Initial Margin Calculation in CDM, please see our previous blog here.
Author: Marc Gratacos the Founder and Managing Partner of TradeHeader, the financial data standards integration and software consultancy.
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