With less than six months to go before the implementation of Phase 6 of the BCBS-IOSCO Uncleared Margin Rules (UMR), in-scope buy-side firms should now be in the advanced stages of their preparations. Firms that fail to meet their margin requirements under the new rules face the prospect of regulatory fines.
Scheduled to go live on 1 September, UMR Phase 6 will lower the average aggregate notional amount (AANA) threshold for in scope firms to $8 billion, compared to the $50 billion AANA threshold introduced in Phase 5. This lower threshold will mean that even more market participants will be impacted by these rules—between 700 and 1,200 additional firms globally, a significantly larger number than the estimated 300 firms which were in-scope for Phase 5.
Of crucial importance is the fact that this lower threshold will bring smaller firms into scope, which typically have fewer middle and back-office resources and differing levels of automation. Automating collateral management systems will be essential in enabling all firms to meet the upcoming UMR requirements.
Is your firm in scope?
But first, all firms need to know if they are in scope. The first step firms need to take is to conduct an in-scope assessment. Some buy-side firms prefer to conduct their own high-level analysis of AANA ahead of their regulator’s mandated observation period, as this provides them with an early heads-up on the potential impact of the rules. Once a buy-side firm has established that it is in-scope for Phase 6, it should communicate to its trading counterparties that they are required to prepare for the implementation of the regulation. This communication should prioritize the firm’s key counterparties since it is likely that these will most rapidly reach the $50 million initial margin (IM) threshold for exchanging collateral. IM exposure is calculated based upon the risk sensitivity of in-scope trades – as part of this process, buy-side firms will be required to agree the basis for the calculation Standard IM Model (SIMM), or Grid and then plan to submit their respective data to test the process.
For phases 1 -5, the majority of in-scope market participants opted to calculate and IM exposures using vendor solutions. Such services also offer ‘trigger’ services which monitor IM exposure on an ongoing basis and advise clients when certain pre-determined levels are reached. While this approach to IM calculation is recommended, margin disputes can occur and counterparties need to be prepared for this potential outcome by establishing a dispute investigation and resolution process.
Automate the collateral management process now
Once it is confirmed that a firm is in-scope, it is recommended that they consider the automation of their collateral management process in order to achieve the levels of efficiency required to meet UMR Phase 6 requirements. An automated collateral management system will provide firms with the ability to calculate exposure across all outstanding derivatives contracts; match and agree on exposure with counterparties; agree eligibility and haircuts of proposed IM and variation margin (VM); and finally, receive and settle IM and VM. Automated collateral management processes can also assist market participants in monitoring and tracking concentration risk which can arise when limits of a certain class of collateral are exceeded or when they accrue excessive exposure to a specific issuer.
At the same time, automation can also help with the new settlement requirement related to UMR, mandating the use of third-party segregated accounts to secure counterparties.
There are two types of third-party segregated accounts – one of which is a fully-managed service offered by tri-party agents. The other is a simpler service based upon instructions sent by the pledgor to deliver or recall specific pieces of collateral. The real issue with this requirement is that opening either one of these account-types at a custodian bank and ensuring your counterparty has all the relevant details can be a long process. In addition to this need for documentation, there is an ongoing requirement for both parties to be able to send and receive instructions and confirmations to and from the custodian.
The good news is that the significant number of Phase 6 firms which may have little or no experience of setting up the required account structures or the associated messaging would benefit from automated vendor solutions. In fact, automated solutions have been widely adopted by buy-side firms impacted by Phases 1-5. The automated calculation, matching and settlement options offered by third-party providers are all being applied to existing margin agreements where firms see benefits in speed, accuracy and certainty of completion of the margining process.
While in-scope firms are faced with the need for extensive preparations to get ready for the implementation of UMR Phase 6, it provides impacted firms with an opportunity to increase automation and introduce best practices in their collateral management processes. These improvements will not only help to deliver greater operational efficiencies and assist firms in complying with the regulatory mandate, but will also lead to the more efficient use of collateral, therefore improving their overall capital and liquidity management capabilities.