The largest banks made their September 1 deadline to comply with new CFTC margin rules, but it wasn’t easy, and firms still face more work ahead to meet the next deadline of March 1, 2017, when another set of margin rules goes into effect.
That was one of many takeaways from a panel at the 2nd Annual Collateral Conference for the Americas, hosted by DTCC-Euroclear GlobalCollateral on September 20 in New York.
The panel, “The Sell Side Balancing Act,” offered attendees the opportunity to hear from global banks and learn how they met their September 1 deadline to comply with Mandatory Initial Margin (IM) rules. Another set of rules for Mandatory Variation Margin (VM) will affect all buy- and sell-side firms on March 1 of next year.
Robust Collateral Management
The new CFTC rules stem from the Dodd-Frank Act and the financial crisis. The rules were created to ensure firms employed robust collateral management processes and enough capital is set aside by banks to ensure their soundness in times of market stress. Aimed primarily at the OTC derivatives marketplace, the rules impact banks across all asset classes. Because the rules are mandatory, more trades are expected to require collateral, which will put greater demand on banks capital. Consequently, banks are searching for ways to more efficiently manage their capital. If firms can better optimize their capital, they can save money.
The next phase of compliance in March, often referred to as “Big Bang,” will force thousands of firms to meet the new law. Panelists recommended that firms stay focused on moving forward to be compliant on March 1. Panelists suggested that firms focus on meeting the deadline, and then revisit afterward to tie up loose ends to make it more efficient.
“We learned that you can never put the pencils down, to keep pushing,” advised one panelist. “Get it done and work to get in compliance. You can always fix things later.”
Advising for March 1
“Engage right away and move it forward,” suggested another speaker, adding that it wasn’t easy for big banks to meet the September 1 deadline. He pointed out that banks have dedicated collateral management teams “who understand this better than anyone,” yet they were stretched and just reached their deadline at the end.
To meet the September 1 date, the industry created five working groups that involved 700 people. Because of the complexity of what the banks faced operationally, many often wondered whether the rules were actually going to go into effect. They did. However, only the U.S. and Japan have put the rules into place. The rest of the world’s markets have delayed implementation.
“It’s not optimal and there are still inefficiencies that need to be removed, but we’re covering the risk as intended,” said one panelist. “A lot of people deserve a ton of credit for getting there as fast as they did. The last two weeks of August were crunch time.”
The panelist also said that firms did not alter their level of trading when the rules kicked in. Many wondered if firms would throttle down their trading because of the new rules’ complexity and their impact on capital. But that did not happen.
Other key takeaways include:
- Avoid collateral disputes, as they are punitive. If there is a dispute, a firm has to take a capital charge for the full amount of the dispute, which is detrimental to a firm’s balance sheet.
- There is value in a utility-like service like DTCC-Euroclear GlobalCollateral. Settlement information is easier to manage, as each participant inputs their own information. A utility model also gives firms a variable cost structure, as opposed to the fixed costs model firms are now operating under.
- Firms may need to replace systems because the new rules are complex and the expected increase in collateral transactions. With the new systems, firms may also look to hire additional employees with different skill sets to both better comply with the rules and operate the new technology.
- Cross-border applications will require a more long-term solution. In addition to understanding when to apply which rules, they noted that consideration also had to be given to the reach of the regulation.
- Increased standardization and automation will be necessary to ensure successful rule implementations during phase two in March 2017.
“It’s not just the ability to have collateral centralized in one place. I think it’s very important that the commitment themselves get centralized in one place so that if you want to optimize collateral, then you optimize across the full portfolio of commitments that you have and you make the best decision to meet all those regulatory regimes and commitments that’s now a reality for all of us.”