Regulations for BCBS-IOSCO’s uncleared margin rules (UMR) for uncleared OTC derivatives began to be implemented in 2016, originally with five annual phases in scope. In response to the global pandemic, international regulators reacted by delaying Phase 5 and creating a further phase – phase 6. Phase 5, the latest implementation, became effective this past September impacting over 300 firms. Phase 6, scheduled for September 2022, is expected to bring even more firms into scope.
At the DTCC-Acadia “Time to Prepare for UMR Phase 6” virtual event, experts from MetLife, DTCC, Acadia and ISDA shared experiences, lesson learned, and details about how firms have improved their collateral processing workflow in preparation for UMR compliance, and how they should best prepare for Phase 6.
Related: CSDR & UMR: Are U.S. Firms Prepared?
Speakers included Bob Stewart, DTCC Executive Director, ITP Product Management: Duncan Scott, DTCC MTU Product Development; Amy Caruso, ISDA Head of Collateral Initiatives; Tara McCloskey, MetLife Managing Director; and Sarah Powers, Acadia Head of Sales, Americas.
UMR’s upcoming Phase 6 will lower the average aggregate notional amount (AANA) threshold for firms to be in scope to $8 billion – this will be implemented on September 1, 2022. Firms that fall into this category need to allow ample time to prepare systems, processes, documentation and custodial relationships, in order to stay in compliance.
Counterparty Disclosure
Once a firm determines they are in scope for Phase 6, it is important to determine which trading relationships will quickly reach the USD 50 million exposure threshold (at which point both parties are required to post Initial Margin), which will eventually reach the threshold, and which will probably never reach the threshold. This prioritization will highlight the need to immediately notify the key counterparties, either via a bilateral self-disclosure letter or a multilateral process. McCloskey emphasized that with time at a premium, firms need to identify their most important trading counterparties, and prioritize these relationships. She added that, at this point, firms need to let not only their own custodian know, but also their counterparty’s custodian. Custodians are dealing with multiple firms that are in scope for Phase 6, so it is vital to make sure that counterparties and custodians are clear on your needs and expectations at an early stage.
Margin Calculation
The next key element that Phase 6 firms need to consider is the process required to calculate Initial Margin (IM). Caruso explained that IM differs from variation margin (VM) in that IM is gross, two-way margining based upon risk factors and not net present value. Firms will calculate the required IM to deliver and receive. McCloskey highlighted that this effectively means that four numbers need to be calculated and then reconciled. To calculate the IM requirement, firms can choose either a standardized grid provided by the respective regulator, or the ISDA Standard Initial Margin Model (SIMM). When choosing, McCloskey pointed out that there are pros and cons to both the SIMM and standardized grid models, therefore each firm should analyze the complexity of their book, considering the term, the asset class and product mix, to decide which works best for them. In addition, there are a variety of outside vendors that can provide an evaluation of a firm’s book to determine what will be the best process for them and the required resources and time needed to test related submission, calculation and reconciliation processes. McCloskey noted that disputes are a possibility and so allowance for these, and their resolution needs to be built into the process.
The best way to prepare for Phase 6 is to focus on relationships that will hit the IM threshold soonest to ensure a continuation of trading with no disruptions.
Regulatory Relief and Threshold Monitoring
As a part of their response to the global pandemic, global regulators offered further relief by removing the requirement for firms to prepare to exchange margin immediately on all in-scope trading relationships. Instead, regulators have allowed firms to monitor IM thresholds for an indefinite period so long as they are ready to exchange margin once the threshold is reached. Considering this relief, firms should assess how quickly counterparties will hit the threshold to determine how quickly they need to be compliant. The main priority, McCloskey noted, is being able to trade day one of the regulatory implementation.
Following this, firms should focus on margining documents for key counterparties. Stewart surmised that the best way to prepare for Phase 6 is for firms to focus on relationships that will hit the IM threshold soonest, to ensure a continuation of trading with no disruptions, while also planning to monitor other relationships that will be slower to meet the threshold.
Given the number of firms in scope for Phase 6, custodians will potentially have a bottleneck of outstanding documentation with many firms requesting onboarding. It is vital to check with custodians and allow plenty of time to have their documentation processed before the regulatory deadline.
Automating the Collateral Process
A final feature of UMR is the requirement for IM to be held in a segregated account at a third-party custodian. Acadia and DTCC offer connected, automated solutions to the UMR workflow which can be integrated to firms’ existing processes.
Powers explained that Acadia’s Initial Margin Threshold Monitor (IMTM) service responds directly to the market’s need for a mechanism to monitor those trading relationships which will eventually come into scope but will take some time to do so. The service features automated notifications when pre-determined ‘trigger-levels’ are reached, which allow both parties to start to prepare for margin calls.
In addition, Acadia’s Margin Manager service works for Initial Margin calls in a very similar way to existing variation margin call processes. There is a specific workflow for margin calls which will be settled at triparty venues which firms should familiarize themselves with since they will certainly be receiving margin in this way.
Scott explained that DTCC’s Margin Transit Utility (MTU) is directly connected to Acadia’s Margin Manager, and from there delivers automated margin settlement directly to the two types of segregated account structure that are available. Phase 5 has seen a number of firms opting to use the simpler third-party custodian model, whereas previous phases saw participating firms prefer to use the triparty model. In either case, MTU removes the requirement for firms to self-build or rely upon manual processes to improve settlement efficiency and reduce operational complexity and risk for collateral call processing. The unique advantage of a recognized utility is that MTU takes manual processes, such as faxes, out of the segregated account instruction process, and is live with a large number of triparty venues.
Embracing a straight-through process and automation has helped with both cost and efficiency. Stewart concluded by cautioning firms not to wait, start calculations, and communicate with global custodians and counterparty custodians.