UMR – Understanding the Buy-Side Impact and Priorities
In a recent interview with Global Custodian, Duncan Scott, DTCC Margin Transit Utility (MTU) Product Management Consultant, looked at how Uncleared Margin Rules (UMR) will impact the buy-side community.
UMR at a glance:
The first four phases of UMR have come into force in stages since 2016 and have affected banks. Many more firms, most on the buy-side, will come into scope with phases 5 and 6, which are now delayed 12 months to September 2021 and September 2022, respectively.
Regulatory initial margin (IM) in the over-the counter (OTC) derivatives space will be a new operational burden for many of these firms. Phase 5 firms with an aggregated average notional amount (AANA) of more than EUR/USD 50 billion will need to exchange IM with their counterparties for swaps that are not centrally cleared as of September 1, 2021. The AANA threshold will drop to EUR/USD 8 billion for Phase 6 firms from 1 September 2022.
How do UMR phases 5 and 6 affect the buy-side?
UMR’s requirements for posting initial and variation margin and mandatory central clearing of OTC derivatives are raising margin call volume and the amount of collateral required substantially. Furthermore, UMR mandates that IM be posted by both counterparties to each other and this two-way margining be held in segregated account structures.
Phases 1 to 4 covered banks but phases 5 and 6 will predominantly impact funds and institutional investors. When these phases take effect they will put stress on buy-side operating models and introduce new costs and regulatory reporting requirements for these firms.
What firms will be impacted?
The size of a firm’s AANA of derivatives is the determining factor. Firms can perform a relatively quick, two-step check to see when they’ll come into scope. For phase 5, in-scope firms will have an AANA of non-cleared derivatives of EUR/USD 50 billion or more - but they need to start posting initial margin only where their IM calculation versus a particular counterparty exceeds EUR/USD 50 million. Then, the AANA threshold will drop to EUR/USD 8 billion for Phase 6 firms beginning 1 September 2022.
What are some key challenges of UMR implementation?
First is the in-scope assessment process. Second is calculating the requisite initial margin, a risk-based calculation. Models are available to do it and firms need to decide whether to outsource this piece of work. Firms should also establish a process for agreeing to the amount with their counterparty. In phase 5, a lot of firms will be very new to these activities and may not have the resources to carry them out internally. Then, having calculated the amount, firms must find a way to pay it, bearing in mind the need to use segregated accounts.
Can you offer guidance for how to evaluate whether to outsource or handle in-house?
I recommend doing a gap analysis of your firm’s skillset. If you're already posting margin, calculation of IM may be the only new thing you need to master. And that’s the piece I would focus on - getting help with the calculations, using the existing models that are out there.
Other aspects of meeting the regulations, such as connecting to tri-party providers or a third-party custodian, are within the realm of a lot of operations departments.
UMR requires that the model used to calculate IM is subject to back-testing and the responsibility to do this testing remains with each firm. Use of a common industry model will allow you to meet the UMR requirements and minimize your compliance risk. Also, talk to your settlements department about their existing repo, tri-party and securities lending facilities, then piggyback off them where possible. Account opening is proving quite a problem for some firms. Some of those hurdles are removed if you have an existing relationship.
In terms of upskilling, maybe you lean on your specialist settlement staff to determine what the firm as a whole can do, rather than worry you've never done a particular thing before in your area.
Besides the operational challenges and resource constraints, what other aspects of UMR will be difficult for the buy-side?
Keep in mind that as well as posting IM to a segregated account to secure a counterparty, buy-side firms also have to onboard wherever their counterparty chooses to secure them. This represents both a documentary and operational challenge.
How can DTCC help?
DTCC helps firms simplify and streamline compliance with emerging regulations. We saw an opportunity to do this for UMR and developed our solution – the Margin Transit Utility (MTU).
MTU automates the margining process from point of agreement through to settlement. It applies automation to the validation, enrichment, settlement, reporting and monitoring of matched collateral calls globally. MTU incorporates a feed from AcadiaSoft, which provides matching for 70% to 80% of the industry’s margin calls. We're connected to the SWIFT network so, very simply, we get a message from AcadiaSoft that says party A and party B have agreed to move collateral in the following form from one to the other.
To get collateral settlement instructions, MTU leverages DTCC’s Alert® standing settlement instructions (SSI) database, which is the industry standard for settlement instructions, then SWIFT messages are generated to the custodians and, tri-party agents and/or paying agents.
What about the credit and liquidity risk firms incur from UMR?
MTU also helps firms manage credit and liquidity risk by accelerating the distribution of settlement data. Because MTU acts for both parties, upon receipt of the collateral both payer and payee can share the status update. This transparency allows firms to work with real-time settlement rather than assumed settlement, which is quite important for credit and risk managers as well as treasurers in financial institutions. With assumed settlement, by contrast, firms book what they assume was paid or received but the next day may learn there was a break or a fail and have to unwind or make adjustments.
Why is margin call automation important?
Technology upgrades have accelerated trading and post-trade processing across many asset classes, yet much of the activity around margin calls and collateral movement remains untouched by automation. The result: margin calls today still rely in part on faxes, emails and manual processes – which slows processing, impedes transparency and increases error rates.
MTU delivers the automated workflows firms absolutely require in order to meet the rigorous operational demands of rules like UMR and avoid the financial penalties for noncompliance
This article was originally published in Global Custodian. For more from DTCC’s experts about how the buy-side can prepare for the compounding impact of regulations such as CSDR, SFTR and UMR, read the full Global Custodian supplement here.
To learn more about MTU, please visit http://www.dtcc.com/mtu.