Notices to Members

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Notice I-22-15

May 18, 2022

Proxies and Approximations Related to Alternative Reference Rates and Other Indices for Initial Margin Model Purposes

Since October 2020, NFA has allowed swap dealers (SD) to include the Secured Overnight Financing Rate (SOFR) in ISDA's Standard Initial Margin Model (SIMM) calculations by using an overnight index swap proxy, subject to certain conditions. NFA is aware that SDs may use alternative reference rates or indices other than SOFR for discounting purposes and trade products based on these reference rates or indices. Since these rates or indices may not be directly modeled in the SIMM framework, SDs using these alternative reference rates or indices must map each rate to a proxy (i.e., the closest equivalent curve in the IM calculations) to include the exposures in the SIMM's calculations.

CFTC Regulation 23.154(b)(2)(xi) prohibits an SD from incorporating any proxy or approximation used to capture the risks of the SD's uncleared swaps unless it first demonstrates to the CFTC or NFA that the proxy or approximation is appropriate. NFA will not object to an SD including alternative reference rates or indices in SIMM calculations by appropriate proxy or approximation subject to the following conditions:

  • The SD emails NFA at swapsmarginmodel@nfa.futures.org that it is incorporating alternative reference rates or indices by proxy or approximation (and identifies the alternative reference rates or indices) in its risk management system;
  • The SD's model risk management (MRM) team issues an approval, a preliminary positive opinion or a waiver to include alternative reference rates or indices for the exposure margined via SIMM (which may include establishing effective compensating controls or an enhanced monitoring framework to ensure the conservativeness of IM calculated using SIMM); and
  • If the SD's MRM team authorizes alternative reference rates or indices by waiver, the team must establish a timeframe to conduct its in-depth review of the introduced proxy or approximation in the IM framework within six months of production implementation.

As part of the MRM team's validation activities to include an alternative reference rate or index exposure in SIMM, via a proxy or approximation, the MRM team must, at a minimum, consider the following:

  • Scope of the approximation for each curve (i.e., new products and/or discounting and affected trade volumes as measured by trade count, notional amount and risk sensitivity amounts);
  • Impact on the SD's risk profile of its existing portfolios; and
  • Anticipated impact on SIMM ongoing monitoring testing results (backtesting, benchmarking and risks-not-in-SIMM) for current portfolios due to the introduction of new products and discounting curve changes.

SDs must have policies and procedures for identifying and evaluating proxies and approximations used in the SIMM framework, as well as for identifying and addressing deteriorating performance, including:

  • A methodology to conduct a quantitative assessment of the proxy or approximation's impact on the IM amount;
  • Thresholds for escalation;
  • Compensating controls; and
  • Remediation.

NFA will review each SD's implementation of alternative reference rates or indices in its risk management system and in SIMM (via proxy) at a later date and will focus on the MRM team's validation activities.

If you have questions please contact Alessandra Riccardi, Managing Director, Model and Risk (ariccardi@nfa.futures.org or 212-513-6029) or Antonina Harden, Director, Model and Risk (aharden@nfa.futures.org or 212-513-6040).

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