Mitigating Risk, Engaging Industry

Uncleared Margin Rules to Achieve Unprecedented Milestones in Final Phases

By Corinne Lee | Dec 16, 2019

Uncleared Margin Rules to Reach Milestones

More than 115 attendees from buy-side, sell-side and custodian firms gathered at the 5th APAC Collateral Management Forum recently in Singapore organized jointly by DTCC-Euroclear and AcadiaSoft, to share guidance and best practices to comply with the Uncleared Margin Rules (UMR) for Phases 5 and 6.

In her welcome address, Purtini Joshi, Head of Collateral Sales for the Asia Pacific region at DTCC, noted, “The industry is facing immense challenges ahead given that the number of in-scope firms for Phases 5 and 6 will increase ten-fold from previous phases where a total of about 100 firms were caught globally.”

She continued, “It is important to note that these collateral management milestones are unprecedented with no comparable historical benchmark. Dubbed in the industry as the IM Big Bang, Phase 6, will witness a record number of buy-side firms, including regional banks, asset managers, pension funds, insurance companies and corporations to start exchanging two-way margin. The challenge is not just about numbers – estimated at more than 1,000 affected buy-side firms, spawning approximately 9,000 counterparty relationships, some of the firms in the next two phases have historically never exchanged margin. They are essentially small, manual, less sophisticated and resource constrained. Due to their size and limited exposure to derivatives, these firms are often reluctant to invest in solutions to automate their operational processes. This will likely affect their ability to trade efficiently with counterparties that have already moved to automated processes since the UMR came into effect.”

Managing Operational Efficiency for Phases 5 and 6 Firms

Joined by Oliver Baughan, Director, APAC Head of Collateral Operations, Bank of America Merrill Lynch; Karin Chabane, Regional Head of Collateral Service, APAC, Citi; Frederick Shen, Senior Vice President and Head of Business Management for Global Treasury, OCBC Bank; and Dan Sleep, Vice President, Specialist, Derivatives Practice, The Northern Trust Company; Joshi led the discussion on the specific challenges that Asian firms will face in getting operationally ready for the final phases of IM requirements.

Under the UMR regulations, firms have the option to decide on the methodology for IM calculation – the ISDA Standard Initial Margin Model (ISDA SIMMTM) or GRID. While the ISDA SIMM is commonly used in Asia, panelists agreed that market participants should pay careful attention to calculating IM according to business specifications as there may be challenges that will impact operational processes resulting in potential disagreements later.

There is also time zone concerns when posting margin with overseas counterparties – i.e., should the cutoff be end of business day in Singapore or London or New York? As a result, there is reconciliation sensitivities to be dealt with as well as equipping operations staff with the required skills to manage new operational demands.

As UMR requires IM to be posted two-way for all trades, firms with several subsidiaries will need to work out with their counterparties on the processes for posting IM at the group or parent level and operational level and reconcile the exposures for both parties. In addition, as part of the compliance due diligence procedure, firms need to diligently monitor their group and operational IM exposures and ensure that the IM threshold is effectively distributed across the group.

According to the panel, tying these moving pieces together is not an easy task that can be handled manually. A streamlined, automated process is required to help firms determine the entire margin exposure and the cost involved.

Unlike variation margin where payments are usually made daily in cash, firms will most likely exchange securities for IM on non-cleared derivatives trades. The key question during the implementation process is to identify a cost-effective solution to process margin exposures and optimize the mobility of eligible collateral taking into consideration opportunity cost and liquidity impact.

Understanding Operational Procedure for Segregated Accounts

As the IM rules require firms to set up segregated accounts at a third-party custodian, the complication of managing collateral movements may push firms to outsource collateral management to either a triparty agent or a third-party provider.

When using a triparty provider, both parties will first have to agree on the required value or Triparty Required Value of the collateral. Following which, the triparty provider will select the collateral and shift from the pledger’s account to a segregated account for the secured party.

In the case of third-party arrangements, each counterparty will have to establish accounts at a custodian for margin segregation. The collateral pledger will have to instruct the appointed custodian to move the collateral to the segregated account on behalf the secured party or counterparty. Counterparties must agree to the margin exposure and eligible collateral before instructions are given for the custodian to execute the collateral movement. Depending on the documentation, secured parties or both counterparties must authorize the release or recall of excess collateral.

Calculating IM Using the ISDA SIMM on Behalf of Counterparties

Given that dealers already have the infrastructure in place to calculate IM using the ISDA SIMM following their experiences with previous IM phases, the panel reviewed a question from the floor on getting the dealer to calculate IM using the ISDA SIMM on behalf of small buy-side firms. While the push in this direction will remove the element of independence from the equation, panelists agreed that this is a viable option if regulators are receptive to delegating the calculation of IM using the ISDA SIMM to a counterparty. That said, an appropriate framework should be established to calculate IM using the ISDA SIMM to ensure proper and good governance.

Invited to share his views, Rahul Advani, Director of Public Policy for Asia Pacific from ISDA, commented, “In bilateral discussions, some regulators in Asia have indicated that they are open to the buy side relying on their counterparties to handle the calculation of IM using the ISDA SIMM. Regulators are sympathetic towards firms that may not have the technical capability and resources to manage the complexity of implementing the ISDA SIMM. However, these regulators have also indicated that they would prefer if a third party is appointed to validate the ISDA SIMM calculation, and clear guidelines should be defined. However, discussions are still ongoing on this subject.”

Bracing Ahead for the Big Bang Compliance Dates

As the September 1, 2020 and 2021 deadlines for the final phases of IM compliance may seem like miles away from today, Joshi urged firms to start thinking about the practical issues, not just the repapering work but the broader scheme of things that involves many aspects of the rules including ISDA SIMM implementation, custodian selection and onboarding, activating collateral schedules and finally operationalizing margin calls and collateral settlements.