Initial Margin - It's complicated: Why backtesting is so challenging... yet so important
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Unpacking the complexity
With phase 6 of Uncleared Margin Rules (UMR) coming into force in September 2022, firms have been looking at backtesting and trying to make sense of it.
Whether a phase 5 and or phase 6 firm must conduct backtesting varies by jurisdiction and geographies, with many regulators yet to define how to apply backtesting rules. Regulatory requirements aside, though, backtesting is a crucial part of the ISDA's Standard Initial Margin Model (SIMM), serving as the validation lynchpin for margin calculations, and is a key element of sound risk management and good governance. But it also can be one of the most complex and challenging aspects of the process, as firms navigate the nuances of regulations, calculations and data requirements.
This article outlines:
- A comparison between dynamic and static backtesting
- Data requirements and methodologies for backtesting
- Importance and benefits of backtesting in the Initial Margin context
- Best practices and the right expertise and tools
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