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The last waves of the day under the glow of a setting sun are usually the most soothing and calming compared to the ocean activity during the day.

However, in the context of Initial Margin rules around the globe, the last two of the five waves will be anything but peaceful. But with proper planning and industry collaboration, the operational, documentation and liquidity management impacts of waves 4 and 5 can be mitigated.

Initial Margin implementation is a five-year, five-phase process underway as part of the Uncleared Margin Rules (UMR), through the Basel Committee on Bank Supervision and the International Organization of Securities Commissions and multiple global regulators (see sidebar). The UMR requires that:

1)     Initial Margin is calculated using either a regulator-provided standardized chart or regulator-approved model.

2)     Initial Margin must be posted within a segregated structure, and in some jurisdictions, this is further restricted to not allow affiliates of either of the counterparties.

3)     Eligible collateral is prescribed by regulations, including concentration limits in some jurisdictions.

4)     The Initial Margin Threshold, which is the greatest amount of exposure before a counterparty sends a margin call, is $50 million.

5)     The Minimum Transfer Amount for both Initial Margin and Variation Margin, which went into place in 2017, is $500,000.

6)     Settlement is required to be T+1, with some caveats for time zones.

The requirements for UMR first went into place in September 2016 for the largest dealers, and have been phased in annually ever since. They will continue through September 2020 and will require collateral management workflow changes, documentation updates with counterparties and custodians and liquidity management challenges.

Phase 4 and 5 Impacts

As the threshold, or Average Aggregate Notional Amount (AANA) that triggers the compliance date for legal entities decreases, more and more regional banks, insurance companies, pension funds, separate accounts, and end users will be impacted by the rules. Specifically:

  • Phase 4: September 2019 - $.75 Trillion AANA
  • Phase 5: September 2020 – All other covered swap entities with AANA/Material Swaps Exposure of $8 billion

Some industry sources estimate as many as 1,000 entities will be impacted by phases 4 and 5 and each counterparty pair will require an updated ISDA Credit Support Annex (CSA) and custodian Account Control Agreement (ACA.) Imagine that each entity has an average of 10 counterparties – that could result in 10,000 updated CSAs and 10,000 ACAs.

The best thing to do for regional banks, buy-side firms, hedge funds, and insurance companies is to begin planning now, even though the next deadline is one to two years away for a majority of the impacted entities.

Coordinating this process not only requires legal resources, but compliance, operations, and front office team members to ensure that investment strategies, operational workflows, and risk reporting can all be adapted or properly updated.

Don’t Forget Calculation Methods and Collateral Structures

Both parties to a transaction have to post initial margin. The two options are: the Standard Initial Margin Model (SIMM) or a standardized chart provided by various regulators. Each method has its own pros and cons. Most Phase 1-3 firms use SIMM because it allows offsetting risk. This can reduce the margin the firm has to post compared to the standardized chart, which requires a percentage of notional. It may be more simple to implement, but could be more costly from a capital and liquidity management perspective.

And while the project management toward implementation will be challenging, it is important for firms to think through how the increased margin call volume and additional data requirements both for calculating Initial Margin and sourcing collateral will need to change day to day processing in the future.

The Uncleared Margin Rules for Initial Margin may be coming in waves, but with proper planning, it need not come crashing down on the firms impacted.

Utilities Can Help Firms Meet Margin Requirements (SIDEBAR)

DTCC-Euroclear Global Collateral Ltd (GlobalCollateral), the joint venture of DTCC and Euroclear, which are two of the world’s largest post-trade infrastructures, offers the Collateral Management Utility (CMU) and the Margin Transit Utility (MTU). These two utilities organize collateral processing and reduce its risk, and process and confirm collateral settlements for margin calls. They are prepared to ensure correct calculation of AANA to meet the new margin requirements.

Learn more about the CMU and MTU from GlobalCollateral