DTCC Connection

Oct 12, 2017 • DTCC Connection

Preparing for Waves of Initial Margin

By Molly K. McLaughlin

Waves of Initial Margin 300pxSpurred by the 2008 financial crisis, regulators around the world created a framework for managing uncleared derivatives’ margin that is meant to increase transparency and reduce risk.

Among the many regulatory requirements, the Uncleared Margin Rules are phasing in the requirement whereby both parties to a trade must calculate Initial Margin, post this margin in a segregated account structure to one another, and implement a dispute resolution process. These new requirements are demanding to the daily management of collateral and impacts operational risk and the need for readily available data to best manage liquidity and counterparty risk.

At the DTCC-Euroclear Global Collateral Conference in New York, firms who have already endured the first waves of the Initial Margin requirements shared lessons learned along with their plans for strategic industry developments to meet the expansive requirements during a panel discussion.

The panel discussion, Preparing for Waves of Initial Margin, featured a lively conversation filled with lessons learned, advice for how the industry could do better, and an exchange of the challenges faced by the different players.

The panel was moderated by Amy Caruso, Director, Strategy and North America Business Development, DTCC-Euroclear Global Collateral Ltd., and featured representatives from the buy-side and the sell-side and custodians, each of which faces different challenges and have sometimes opposing views on how to meet them. The panelists were Michael Belmont, Global Head of Collateral Management, Goldman Sachs Asset Management, Olivier Grimonpont, Global Head of Collateral Management and Securities Lending, Euroclear, Wayne Forsythe, Managing Director, Collateral Management Services, State Street Bank and Trust, and Joseph Spiro, Head of Cross-Asset Collateral & Risk, Societe Generale.

After introducing the panel, Caruso explained that the overall theme was about collaboration and moving from a tactical to a strategic point of view. She encouraged the panelists to share their viewpoints in an effort to educate firms that are new to the concept of initial margin and have not yet entered the planning stages.

Each panelist talked about what they had learned while in the trenches and how firms should plan accordingly and not leave everything until the eleventh hour.

The main takeaways from the panel were:

  • The best way to tackle the Uncleared Margin Rule IM requirements is through expansive planning—getting ahead of the challenges will pay dividends as the future deadlines approach.  
  • Collateral management often employs an inefficient, tedious workflow, and the industry needs to move towards automation. 
  • The need for collaboration and standardization between the buy-side and sell-side to develop innovative solutions. 
  • Creating industry tools that can integrate with the systems that firms already use in other parts of their business will increase efficiency. 
  • Building account structures and processing that can accommodate the IM segregation requirements while keeping costs and operational risks at a minimum. 
  • DTCC's Margin Transit Utility (MTU) is leading the way in solving many of the settlement processing solutions.

Mandatory Initial Margin

Before September 2016, many entities never posted initial margin. Further, segregated collateral accounts were primarily only used by '40 Act Funds for variation margin.

There are two methods to address segregation of collateral —third-party accounts and a tri-party construct—and there were spirited views shared about the merits and downsides of each from the perspective of the sell side, the buy side, and the custodian.

What immediately became apparent is that, while the third-party account method is more familiar to firms that have been posting segregated variation margin for ’40 Act Funds, the current market workflow is manually intensive and prone to costly errors. Repeatedly throughout the discussion, panelists brought up the importance of automation and better industry tools. "I mean faxes and e-mails need to go by way of the rotary phone," one panelist remarked, referring to the onerous task of getting margin releases/recalls manually approved by different stakeholders.

The tri-party construct, in which the process is outsourced to an agent and is highly automated, was generally agreed to be more efficient and cost-effective, particularly by the sell-side.

The buy-side, however, is concerned with outsourcing fiduciary responsibility to another party. Losing that control over the process can feel risky when a firm has clients and investors relying on them.

What's next?

In addition to the segregation requirement for Initial Margin that can be accommodated by the third-party account or tri-party account structures, there is also a requirement to calculate Initial Margin and deploy a dispute reconciliation process when there are breaks between the counterparties’ exposure calculations.

One way to mitigate the disputes is to use a common margin calculation methodology. The panelists discussed the ISDA SIMMTM, the Standard Initial Margin Model, along with the AcadiaSoft dispute reconciliation tool, Exposure Manager for IM, which can be used by all parties to calculate their initial margin and communicate breaks. The combined solution reduces the possibility of disputes and makes it easier to resolve disputes when they do arise. Panelists stressed that firms get the process in place in advance. "Waiting until the end is not an advisable strategy," one panelist said.

One way to mitigate the disputes is to use a common margin calculation methodology. The panelists discussed the ISDA SIMMTM, the Standard Initial Margin Model, along with the AcadiaSoft dispute reconciliation tool, Exposure Manager for IM, which can be used by all parties to calculate their initial margin and communicate breaks. The combined solution reduces the possibility of disputes and makes it easier to resolve disputes when they do arise. Panelists stressed that firms get the process in place in advance. "Waiting until the end is not an advisable strategy," one panelist said.

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