Over the past several months, the entire financial industry, and the world, has had to radically adjust how we work together. This is especially true with crucial functions like managing margin calls. This topic has received greater attention than usual, in the same way that we often notice something when there is trouble – and when market volatility has created a perfect storm of asset sales and margin calls. The increased activity has highlighted that, in our age of digitalization, many still rely on faxes, emails, and phone calls to manage their margin call process, creating inefficiencies in the best of times, and now potentially higher error rates and financial losses.
The experience of dealing with the spike in margin calls at the beginning of the COVID-19 pandemic reinforced that this critical process should be fully automated. In response, firms should now adjust to the virtual “new normal”, while staying ahead of regulations and creating lasting efficiencies. Here we explore each of those areas.
1. The need to adjust to virtual procedures across the industry
The current margin call management process still relies heavily on manual processes such as emails, phone calls and faxes. While most firms can still manage these activities in a remote environment, some are hindered by manual checks that require two levels of review. Any process that mandates employees and clients to be physically present may no longer be possible, and there is an immediate need for firms to adjust their processes accordingly. Further, simply replacing in-person checks with digital but still manual versions of those processes, like shifting documents that request ink signatures to documents that require digital signatures, do not necessarily bring increased security to the system or make it more efficient.
It is notable that there are some firms that have been leading the charge in automation in this area. But the efficiencies and robust practices of these firms are undone when automation is not industry standard. If one party is automated but their counterparty is manual, it prevents true efficiency from being achieved, and can discourage further investment into automation for the whole industry as laggards slow innovators down.
2. The need to stay ahead of upcoming regulations
Before 2020, the track towards margin call automation was clearly paved due to upcoming regulatory mandates. For example, firms were working towards being compliant for deadlines including Securities Financing Transactions Regulation (SFTR) and the final two phases of uncleared margin rules (UMR) for derivatives. As a result of the pandemic, these deadlines have been deferred to allow firms the bandwidth to focus on daily operations. While these delays are clearly crucial, there is concern in the industry that this shift back in regulatory timelines may further delay important technology and processing upgrades. To avoid this stagnation, firms need to balance the resources they devote to daily operations with investing in automation and ensuring compliance with regulations that loom on the horizon.
As a start, firms should be looking at current manual processes and review how they performed under the recent spoke of volumes, assessing strengths and weaknesses. Then, firms should analyze the steps needed to improve current weaknesses, with an eye towards compliance with future regulatory requirements. After this groundwork is complete, firms can work with the broader industry, including technology providers and utilities, to develop a path towards automation.
3. An opportunity to create lasting benefits
Crisis events are often the push the industry needs to make true operational improvements that prepare us for the next crisis, whatever it may be. For example, 9/11 propelled firms to improve their business continuity procedures and disperse operations across multiple sites, improving the resilience of a site-specific crisis. Similarly, the 2008-2009 crisis prompted regulation to bring transparency to the financial industry and the flash crash brought in circuit breakers to halt trading during massive volatility.
Today’s moment has highlighted the current inefficiencies in the margin call process, and the clear need for targeted and lasting changes. The increase in volatility that created a spike in margin calls appeared during the financial crisis, repeated during this pandemic, and is sure to happen again . As we create a “new normal” for the industry, bringing automation and innovation to margin calls can help create a process that is more efficient and secure, and positions us well for future regulatory compliance and high volatility events. We have seen some firms start on this path, and we should leverage this crisis as a call to action to make the automation of margin call processes the industry standard.
This article was originally published in Traders Magazine.