Executive summary

The over the counter (OTC) derivatives market highlighted the significant amount of leveraged and unmanaged risk undertaken by several financial institutions during the Global Financial Crisis in ~2008. They did so without maintaining or posting adequate margin between counterparties.

In March 2015, the Basel Committee on Banking Supervision (BCBS) and the International Organization of Securities Commissions (IOSCO) published the final policy framework that established the minimum standards for margin requirements for non-centrally cleared derivatives.

The BCBS and IOSCO had both agreed on the terms and implementation timeline of the framework, which was launched in September 2016 as Unclear Margin Rules (UMR). Since then, UMR has been implemented in a phased manner by the eligible financial institutions.

Further to this, the European Banking Authority (EBA) has been mandated to develop regulatory technical standards (RTS) to specify the supervisory procedures that would ensure initial and ongoing validation of the risk management procedures covering exchange of margins for financial institutions in the European region.

The EBA released a draft of the RTS for validating initial margin (IM) models on July 3, 2023, under Article 11 of the European Market Infrastructure Regulation (EMIR1). An amendment to EMIR was proposed in April 20242. The draft RTS delineates the steps and methodology for IM model validation (IMMV). The proposed amendment to EMIR suggests changes to various articles of the regulation, but in this paper, we will focus on points related to model validation.