We are counting hours now until the new margin regulation goes live for a greatly increased number of businesses, under phase 5 on 1 September. TriOptima sums up where we are at, how firms have applied its solutions to get ready – and what we can expect to happen now.
Whether it’s a small basil plant in the kitchen, a potted plant on a balcony, or flowers in the garden, all gardeners want to see evidence of growth. Week by week the hope is to see new leaves or flowers blossoming. Just imagine the patience required to grow Chinese bamboo. With no visible growth for four years, everything changes in year five, and in a matter of weeks, the bamboo can grow more than 30 meters in height.
The phased-in approach of global uncleared margin rules (UMR) has been similarly slow. Since 2016, just 70 or so firms have been required to comply across four phases. This all changes on September 1, 2021, when the industry expects more than 300 new organizations to come into scope overnight.
With the industry on the cusp of this significant hurdle, let’s take a moment to assess where we’re at
Phase 5 of UMR is significant for many reasons. Not only does this mean a significant jump in the number of in-scope firms, but it also creates a large impact for the buy-side, hitherto largely out of scope. Without the large-scale resources of the sell-side on hand, and with many firms needing to solve for the added complexity of managed funds, buy-side firms face their own additional hurdles to comply.
Crucially, phase 5 firms have one advantage over those in earlier phases, namely that they have been able to take advantage of regulatory relief which has allowed them to delay some of the UMR documentation preparation steps until absolutely necessary. For most, this has meant fewer resources needed for compliance, allowing them to focus on relationships where Initial Margin (IM) exposure is expected to exceed €50m relatively quickly. And while a good number may end up delaying documentation for months or even years, a smaller number may end up completely avoiding the complex set of legal documentation required of firms in earlier phases.
However, even where firms have been able to take advantage of this regulatory relief, the baseline requirement has still seen them required to put in place new capabilities to calculate and monitor IM. And for those who expect to quickly exchange margin, they have also had to prepare for the exchange of IM by opening custodian accounts and negotiating legal documentation.
While all in-scope firms must calculate IM, how they choose to do this has perhaps been the key decision firms have had to take. Faced with a choice of calculation methodology (SIMM™ vs. schedule), firms have had to evaluate their capabilities to support each, ascertain which model aligns with their portfolios, as well as discuss the model preference with counterparties (or clients). While the ISDA SIMM methodology may have been the default choice in earlier phases, many phase 5 firms – particularly those with directional or vanilla portfolios, or who benefit from a large cushion below the regulatory €50 IM threshold – have been able to give greater consideration to the schedule approach. Potentially as a short-term option, before moving to SIMM in order to gain the maximum grace period under regulatory relief.
While the relief granted by regulators to phase 5 firms stands out as an obvious differentiator to earlier phases, what we have seen in terms of system selection and technology among phase 5 firms also marks a key difference. The larger stature of phase 1-4 firms meant most were able to handle IM calculation and margin requirements in-house. In contrast, phase 5 firms can be characterized by a distinctive shift towards use of third-party providers for large parts of their UMR needs, particularly regarding IM calculation. This can be explained by several factors, including a lack of internal expertise with IM models, a broader shift towards use of dedicated vendors over internal build approach, reduced delivery cost and the short window in which to implement UMR.
In addition to the task of IM calculation, we also observe a difference related to both monitoring and margining tools. Many phase 5 firms had previously managed collateral via legacy vendor or in-house solutions without connectivity to industry tools. UMR highlights the importance of connecting to a wider network of platforms, including triResolve, and Acadia’s Margin Manager and IM Exposure Manager services, and as such, we’ve seen a substantial number of firms implement new collateral solutions as part of their UMR projects. This helps them to prepare not only for IM calculation and exchange, but also helps to resolve legacy issues associated with Variation Margin (VM).
Perhaps the final difference for phase 5 firms relates to the topic of dispute management. While there was near universal adoption of a common industry platform for IM reconciliation (IM Exposure Manager) across phases 1-4, we see greater variety among newly in-scope firms. While larger phase 5 firms – who expect IM to quickly build up – have followed the dispute management route of firms in earlier phases, many of those firms who expect IM exposure to remain below the threshold have taken more of a wait-and-see approach. This approach allows them to simplify their onboarding projects and potentially delay or even reduce overall costs.
While firms may have focused on IM calculation and monitoring ahead of September 1, it doesn’t mean they don’t anticipate IM exposure differences; merely that they are comfortable to live with minor differences while their exposure is small, and to expand their dispute capabilities as and when needed.
While clients have been using our UMR solutions since phase 1, we have seen a huge jump in demand with phase 5. Fortunately, the experience we’ve built-up over four years has been critical to helping clients prepare ahead of the deadline.
Two key things stand-out in terms of client preparations:
1. Early calculation of IM exposure
2. Looking at the end-to-end collateral process, including VM and dispute management
Our team of triCalculate valuation analysts have been working with phase 5 clients since 2020 to help guide them on data requirements and to deliver IM calculations. Wherever possible we’ve focused on providing an early calculation of IM on existing live portfolios. It’s worked as a fantastic way for firms to understand the potential impact of UMR, to understand how IM exposure builds up and to help choose the right IM model for them – and to clearly identify which portfolios might breach the €50m threshold. This, in turn, is critical to determining the broader impact of a firm’s UMR project.
If you identify that you’re likely to breach with several counterparties, you will need to negotiate legal documentation, open custody accounts, and put in place both a calculation and dispute management process. In contrast, identifying that you will likely remain below thresholds for several years, your project takes on a much lighter look and feel, allowing you to focus on IM calculation only. The benefit of early IM calculation also hopefully means no surprises come September 1.
While regulatory relief means phase 5 firms may manage their day-to-day IM operations differently – either monitoring or margining, or a combination of both – our team of triResolve Margin client managers have been helping firms to prepare for both approaches. This includes setup of both regulatory IM agreements and monitoring agreements, integration of data from IM calculators (including triCalculate and Acadia’s IM Exposure Manager) and testing of IM workflows. Where clients have triparty relationships, we have provided automated connectivity to BNY Mellon, Clearstream, Euroclear and JP Morgan, therefore removing the need for manual payment instruction, maximizing STP and reducing the risk of settlement failure.
Regardless of whether phase 5 clients are monitoring or margining, we’ve also helped firms by transforming their broader collateral management capabilities. Nearly all in-scope firms began their preparations by first adopting triResolve Margin to automate their VM process, many doing so months (or even years) in advance. By doing so, they have been able to benefit from immediate operational benefits, including electronic connectivity to counterparties, real-time call exchange and an automated margin workflow.
With IM being calculated on new trades only, combined with regulatory relief to delay documentation, this reduces the day 1 impact for large parts of the market. While all firms should still be able to calculate IM exposure on day 1, the associated operational burden of margin call exchange, dispute investigation and collateral settlement will fall on the shoulders of only a small number of firms. That means the broader impact will only be felt over time rather than a big bang.
Hopefully, this delayed impact allows those firms that require it the additional time to prepare documentation, complete systems implementation and develop procedures to support the end-to-end process.
To learn more about initial margin, visit cmegroup.com/trioptima-im-compliance
Are you in scope for phase 6 of UMR? Listen to TriOptima’s on-demand webinar, run in partnership with Risk.net, and hear from a panel of industry participants as they share best practices and recent experiences with UMR planning. Click here to watch now.
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