Initial margin models on non-centrally cleared derivatives and some implications for systemic risk

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The 2008 global financial crisis highlighted the need to manage counterparty risk, particularly in the derivatives market, as a key element in preserving financial stability. As part of the reforms to Over-the-Counter (OTC) derivatives markets, margin requirements were introduced for non-centrally cleared derivatives. In this article, we present an application of the standardized initial margin framework proposed by the Basel Committee on Banking Supervision (BCBS) and the International Organization of Securities Commissions (IOSCO); using a network contagion model, we analyze the impact of adopting this framework on reducing counterparty risk in standardized swaps in the Mexican banking system. The analysis is based on outstanding transactions as of the end of June 2024 and assesses their effect on contagion risk by simulating changes in the valuation of derivatives over a ten day horizon. The results show that the initial margin scheme not only reduces individual potential losses arising from a counterparty’s default but also decreases the systemic risk that emerges in the network when some institutions trigger a contagion process. In particular, a reduction in the mean and standard deviation of the system’s loss distribution is documented, as well as a consistent decrease in the dependence of upper tails under Student’s t and Gumbel copula schemes, providing evidence of a reduction in the probability of joint extreme losses. Furthermore, a structural characterization of the exposure network is presented for the period from January 2023 to June 2024, which documents the stability of the market topology and supports the robustness of the results. It is emphasized that the availability of granular information allows assessing the effects of adopting these initial margin policies and constitutes an element for the efficient monitoring of their implementation.