From left to right: Moderator Mr. Mark Ho and panelists at the 5th APAC DTCC-Euroclear GlobalCollateral and AcadiaSoft Collateral Management Forum held in Singapore.
While firms caught in the earlier phases of Uncleared Margin Rules (UMR) have led the way for implementation of initial margin (IM), Phases 5 and 6 firms still have a long way ahead. Specifically, what are the preparatory steps for affected firms? How soon should firms get started? What are the documentation and legal requirements?
These questions were the focal point of discussion during the panel session on “Addressing Margin Documentation Requirements” at the 5th APAC DTCC-Euroclear GlobalCollateral and AcadiaSoft Collateral Management Forum held in Singapore.
Moderated by DTCC’s Mr. Mark Ho, Chief Compliance Officer – APAC, and joined by panelists Ms. Victoria Chen, Head of Legal, APAC, DTCC; Mr. Miles Binney, Senior Associate from Clifford Chance; and Mr. Rahul Advani, Director of Public Policy for Asia Pacific at ISDA, the panelists agreed that firms really need to understand the implications of margin requirements for Phases 5 and 6 and what is expected of them to get ready for compliance.
Examining the Impact of Phases 5 and 6
Reiterating that the purpose of the UMR is to mitigate systemic risk, Mr. Advani commented, “The July 2019 Basel Committee on Banking Supervision (BCBS) and the International Organization of Securities Commissions (IOSCO) announcement has introduced an additional implementation phase of IM requirements, after Phase 5. This essentially requires Phase 5 firms with an aggregated average notional amount (AANA) of more than Euros 50 billion to exchange IM with their counterparties for swaps that are not centrally cleared as of September 1, 2020. The AANA threshold will drop to Euros 8 billion for in-scope Phase 6 firms from September 1, 2021.”
Based on preliminary estimates from ISDA, more than 1,000 entities would have been in scope for Phase 5, originally slated as the final phase. This would then require repapering work to be done for some 9,000 in-scope counterparty relationships.
Sharing some interesting projections, Mr. Advani added that with the change in margin requirements, around 3,600, or 40% of counterparty relationships originally in-scope for Phase 5 will need to comply with the regulatory IM mandate on September 1, 2020. The remaining 5,400 or 60% of counterparty relationships will have up to September 1, 2021 to comply with the IM rules. Of those counterparty relationships that are still in-scope from September 2020, between 28% and 41% are likely to breach the IM exchange threshold within the first two years of their regulatory IM obligation, depending on the calculation methodology used.
Given the industry’s concern with compliance and documentation, the inclusion of Phase 6 is viewed as a welcome development. That said, the huge jump in firms captured in Phases 5 and 6 from just over 100 firms caught in previous phases will require massive amount of existing and new documentation to be negotiated putting a huge strain on industry resources.
Monitoring IM Threshold Levels
As the BCBS IOSCO statements specify when a firm is not in-scope but not when it is in-scope, Mr. Advani advised that firms must continuously monitor their threshold levels to remain complaint. He advised, “From our past experiences with the previous phases, it can take between 12 to 18 months to negotiate documentation, implement ISDA SIMMTM calculations, secure IM model regulatory approval if needed, and establish custodial relationships.”
When giving legal guidance on IM requirements for Phases 5 and 6, Mr. Binney highlighted three key messages that in-scope firms should take note: 1. Time is running out; 2. The operational, legal and documentation requirements will continue to grow in complexity; and 3. The scale of the challenge is increasing, as new and revised documentation will be needed for thousands of in-scope relationships.
He elaborated, “It is also helpful to remember that Phases 5 and 6 of will go live about the same time when the effects of Securities Financing Transaction Regulation and IBOR transition are being felt. Financial institutions obligated to comply with these regulatory requirements will thus have to battle with these challenges concurrently.
To provide a sense of the amount of laborious task required, Mr. Binney indicated that the range of templates for the legal documentation in Phase 5 has grown significantly since the earlier phases and is likely to continue as more custodians and other service providers start offering services. The logistical challenges in Phase 6 will be felt most by the smaller buy-side firms that do not have any prior experience with IM negotiations and there will be very little bandwidth for negotiation.
Scoping Out the Work
Providing a quick overview of the preparatory work involved, Mr. Binney said, “Firms will first have to perform an analysis to determine whether they are caught by either of Phase 5 or Phase 6, performing the necessary AANA calculations Then they will have to determine the impact each rule set will have on their operational systems and prepare their legal documentation (including setting up and monitoring the AANA calculations according to each jurisdiction’s margin regulations, as some relationships are regulated by multiple jurisdictions). This will be followed by early discussions between counterparties, including identifying and onboarding with custodian(s) to post collateral and initiating relationships with counterparties’ custodians to receive collateral. The documentation required will largely depend on the custodians and other service providers involved.”
Creating a To-Do-List
Sharing her experience as an in-house counsel on managing regulatory obligations, Ms. Chen remarked. “To kick start the compliance process, it is essential to create a checklist to help firms plan for IM compliance, in addition to having an open dialogue internally to identify roles and responsibilities and know what is exactly required. The analysis to determine if firms are subject to IM requirements should be completed from the onset to ensure that ample time is set aside for system adjustments, if required.”
She advised, “Going into specifics, there is also development work to be carried out that is dependent on how AANA is calculated. For example, calculation for a group of subsidiaries that belong to a principal firm could be done either on a consolidated level, considering the positions of the entire group or based on netted positions at the subsidiary level. Firms must also coordinate the operational procedures for IM thresholds and minimum transfer amount of collateral to be transferred, the application of haircut and movement of eligible collateral. These requirements vary between jurisdictions, and due to the large number of counterparties that may be involved, ample time should be set aside to review existing agreements as well as decide on the approach for negotiating documentation.”
Ms. Chen also pointed out that in special cases, legal opinion may be required on how collateral should be settled for non-netting jurisdictions, bearing in mind local laws and hence make a considered determination if these issues should be handled by an in-house counsel or seek guidance from specialist legal services.
Reinforcing recommendations from the panel that Phases 5 and 6 firms should start sooner rather than later, Mr. Ho summarized the discussion by stressing that an early start will provide firms with more time to manage unforeseen issues and to also avoid the mad rush.