On 28 June 2022, the PRA published a letter setting out conclusions following its review of the use of the SIMM model.

The PRA reviewed the Standardised Initial Margin Methodology (SIMM) model used by large banks with the intention of monitoring how it performed during the COVID-19 pandemic market stress period. It also assessed model compliance against the regulations governing exchange of margin on non-centrally cleared derivatives.

In the letter, the PRA sets out its conclusions and the issues it has identified, primarily around SIMM model governance and firms’ capability to identify and remediate model underperformance on a timely basis.

The PRA believes that, the existing governance process, in which firms rely primarily on the International Swaps and Derivatives Association for updating SIMM or negotiating add-ons for model underperformance, may result, for some counterparties, in margin levels not adequate to cover for risks at the 99% confidence level as required by regulations.

Furthermore, in September 2022, a large number of smaller counterparties, of which many are hedge funds, will enter in scope of the regulation as the roll out of mandatory margining for non-centrally cleared over-the-counter derivatives reaches its close-to-final stage. The PRA expects that a significant share of these funds may have portfolios with risk profiles materially different from those to which SIMM has to date been predominantly applied (i.e. large broker-dealers’ and banks’ portfolios). Hence, it is even more critical that SIMM model governance can enable firms to promptly identify and remediate model underperformance.

Based on the observations and context provided, the PRA expects to see evidence that the risk of under-margining, identified above, is being addressed. Furthermore, firms are expected to take the steps indicated in the Annex by December 2022, and then report the findings to their supervisors.