At DTCC’s annual Asia Pacific Collateral Management Forum, a panel of industry experts examined the new challenges that will affect approximately 1,100 of new in-scope entities in the final phases of Uncleared Margin Rules (UMR).
Recapitulating the regulatory requirements and data provided by the International Swaps and Derivatives Association (ISDA), Purtini Joshi, DTCC Head of Collateral Sales, Asia Pacific, noted Phases 5 and 6 to be implemented on 1 September 2021 and 1 September 2022, respectively, will generate a staggering 9,000 or more separate counterparty relationships. The split of these relationships is roughly 35% in phase 5 and the remaining 65% in phase 6 – where each counterparty firm will have to review their operational, legal and documentation processes to ensure compliance with the IM rules requirements.
“The upcoming phases will bring many asset managers and their underlying clients into scope to exchange Initial Margin (IM),” Joshi said. “The mandate will extend its reach to new markets in Asia Pacific, including Malaysia, South Korea, Taiwan, Thailand, and the Philippines.
“Domestic collateral givers in these markets will be looking to maximize the utilization of local securities and government bonds to meet the HQLA (stock of high-quality liquid assets) criteria,” she added. “From the global collateral taker’s perspective – typically offshore global dealers, they will be considering how to accept these securities as collateral. Aside from domestic legal nuances concerning creation of security interest on local collateral, there are also operational challenges to address.”
Moderated by Joshi, the panel examined the operational issues for entities and their counterparties caught by the rules.
The upcoming phases will bring many asset managers and their underlying clients into scope to exchange Initial Margin.
Comparing Phases 5 and 6 with Previous Phases
O’Delle Burke, J.P. Morgan Head of Collateral Services APAC/Product Innovation, noted that affected entitles in the final phases will have to find solutions for IM calculation whereas entitles in previous phases had in-house capability to calculate the margin to be posted. He said, “We will be seeing more local custodians in markets like Taiwan – instead of European and US custodians which was the case in the past – getting involved. This essentially means that changes in areas like review process, operational set-up, etc., will have to be carried out ahead of compliance date. Aside from Japanese Government Bonds (JGBs) which have been already been included as eligible collateral for exchange, more documentation work and operational mechanics will need to be established for usage of other local collateral increases.”
With many Korean market participants coming into scope for Phase 5, it was highlighted that there will be strong need to use Korea Treasury Bonds (KTBs) for IM exchange. Duncan Scott, DTCC Consultant, MTU Product Development, explained that there may be a bottleneck in providing key services such as custodial management of collateral due to the sheer number of market participants affected.
Deviating from Traditional IM Model
Burke noted that under Phases 5 and 6 of UMR, the operational framework needed is a deviation from previous phases where the exchange took place almost exclusively at triparty venues. “There will now be third party custodians involved in the operational framework supporting the buy-side firm as the pledgor and their counterparty as the secured party,” he said. “On the flip side, phase 5 and 6 firms will still largely be secured at triparty venues, where they will be the collateral ‘receiver’.”
Managing Operational Challenges
Operational challenges may also arise with cross-border exchange of securities. Citing South Korea as an example, the panel mentioned that Korea Securities Depository (KSD) is working on its own framework for IM exchange, offshore counterparties will need to connect with an onshore local custodian to connect to KSD’s framework. This interaction is often supported manually when exchanging variation margin. With IM exchange, these manual processes are not sustainable and may result in costly errors. While firms may explore different methods to leverage SWIFT messaging to connect to the onshore local custodian and hence KSD, it is essentially a workaround.
It was also indicated that in Japan, for example, collateral receivers will now be exposed to many new eligible securities in cross-border transactions. To cope with the operational aspects of registering new eligible securities, firms could work with external vendors to develop a scalable solution to mass register securities.
Scott explained the immediate implication for Phases 5 and 6 in-scope firms is that custodians and tri-parties will need to be onboarded to help operationalize new eligible securities and the margin exchange process. “Instead of relying on time-consuming manual processes or an in-house portal to send and receive messages with offshore counterparties, an automated connectivity approach should be adopted to ensure efficient collateral settlement,” he said. “Firms should leverage market utilities to help solve these operational challenges – to reduce operational complexity and risk. A good place to start is to review the solutions adopted by affected firms in previous phases.”
Because of the heavy operational and administrative burden involved in opening segregated account, Burke observed that firms are rationalizing margin requirements in twofold. First is to review how to spread their trades among the portfolio of counterparties that they have trading relationships and keep IM levels to below the threshold required to post margin. Second is to clear all OTC derivatives transactions via central clearing – if the products are generic.
Firms may consider centralizing certain processes across entities to ease the pre-set operational build. That said, the end decision on which route to take varies from counterparty to counterparty.
Looking Ahead
Before wrapping the panel discussion, Joshi concluded that Asian securities will gain prominence in the margin exchange space as new markets in Asia Pacific come into the scope of UMR. “The question is how soon will these securities become mainstream? To facilitate broad acceptance of Asian securities for cross-border margin exchange, it follows from today’s discussion that firms should start to explore the services of market utility – to make margin exchange efficient and streamlined.”