EMIR Newsflash: PRA takes aim at SIMM
Conclusions of the PRA’s review of the use of the standardised initial margin methodology model by large banks.
Following recent events, including the Archegos default and the Russia-Ukraine war, the UK Prudential Regulation Authority (PRA) has undertaken a review of the use of the Standardised Initial Margin Methodology (SIMM) model by large banks. On 28 June 2022, in a letter to Chief Risk Officers, it released its conclusions.
Issues
The PRA warned that banks using SIMM for uncleared margin rules (UMR) may not be maintaining margin levels adequate to cover their risk.
It has taken the view that the 3+1 back-testing methodology used for SIMM does not achieve the requisite 99% confidence level required to estimate Initial Margin (IM) and that, in any case, the 3+1 methodology does not comply with the P&L testing it considers is required under Article 14(3) of the EMIR Margin RTS (the RTS).
In relation to Phase 6, the PRA is particularly concerned that SIMM is insensitive to non-modelled risk factors – which it considers to be more likely to arise in relation to atypical portfolios held by Phase 6 size entities than was the case in earlier Phases. Hedge funds in particular are singled out, with the PRA noting that their portfolios may be “significantly exposed to risk factors not directly modelled in SIMM”.
The implication is that, for some portfolios, SIMM risks systematically setting the IM requirement at too low a level (ie inadequate to cover risks at a 99% confidence level), in breach of applicable regulation.
Expected Actions
Category 1 banks using SIMM have been given until December this year to provide evidence to their supervisors that the risk of under-margining is being addressed, including by:
- undertaking a self-assessment of their implementation of UMR against the relevant regulations (in particular the RTS), including consideration of:
- the PRA’s observations in the letter
- compliance against Article 14 of the RTS, and
- the role played by P&L back-testing in the firm’s own SIMM model governance. and
- providing a corrective action plan for any gaps identified in 1.
Impact
We are already on version 2.4 of SIMM, which is intended to be dynamic. But in light of these latest conclusions from the PRA, at least some buy-side firms might expect more stringent initial margin requirements under SIMM in due course. Change seems likely.
