Planning Your Initial Margin Compliance: A Six-Point Checklist
Just as the hardy settlers of the western United States, traversed unknown paths across the Rockies, expediting the journey for those who followed, global banks have prepared the way for Initial Margin (IM) readiness for regional dealers and buy-side participants.
By Mark Jennis, Executive Chairman, DTCC-Euroclear Global Collateral Ltd.
The approximately 30 global banks that pioneered the first two waves of IM adoption uncovered some challenges in implementation but also realized tremendous achievements. In the face of daunting deadlines, industry participants banded together to launch new margin calculation models and establish efficient segregation schemes and settlement processes. The results uncovered six suggestions to help the industry prepare to meet its ongoing collateral requirements.
1) Get Out the Calendar and Calculate AANA.
September 2016 started the clock on the five-year phase-in of the requirement that virtually all firms engaged in trading non-centrally-cleared derivatives post initial margin for these transactions.
The phases of compliance, based on the size of a firm’s derivatives portfolio as measured by aggregate average notional amount (AANA), front-loads coverage for the largest sell-side entities. Phase one applied to those broker-dealers with a global footprint; phase two, starting September 2017, impacted additional large banking institutions; phase three, in September 2018, will primarily affect regional banks. Not until September 2019 will the margin rules start to cover the buy side, whose operational structures depart significantly from those of sell-side firms; the majority of buy-side entities covered by IM rules will be impacted in 2020.
This roll-out schedule, while extremely taxing for the banks in the early phases, can benefit the market overall by providing time to gather community input; road-test new processes, account structures, and procedures; and implement necessary documentation.
As the first step to ensure successful adherence to the IM rules, firms need to properly calculate legal entities’ AANA and consider affiliate implications. These calculations in turn determine which implementation phase a legal entity falls into.
2) Innovate—With the Industry.
The new IM regime requires firms to retool multiple and amazingly complicated elements of the margining/collateral management lifecycle, scaling up, overhauling and sometimes outsourcing various functions. Working collaboratively, the banks in the first phase did heroic work to establish various procedures and protocols that will simplify the challenges of mandatory IM for the entire industry.
Among their innovations, two are especially important: IM calculation utilities that can streamline the up-front margin agreement process, and a triparty model moving collateral that is adapted from an existing repo product.
Firms preparing to adopt the new IM rules should explore these tools and be ready to use them when their compliance date is triggered and as volumes increase.
3) Documentation Can’t Wait.
During the first and second waves, many dealers underestimated the amount of documentation needed, the time required for pre-launch testing once documentation was in place, and the complexity of revamping other lifecycle processes.
Going forward, firms should ensure that they have allocated ample time and resources for documentation, onboarding and testing—and rework, if necessary. Collaborating with counterparties to update or create new IM Credit Support Annexes (CSAs) and segregation documentation needs to start far in advance of implementation dates in order to be successful.
4) Implement Efficient Solutions—Sooner Rather Than Later.
Many legal entities will be impacted by the IM rules in 2019 and 2020 because buy-side firms typically manage hundreds, sometimes thousands of legal entities—one for each of their client accounts—and each trades with multiple brokers. This structure translates into thousands of collateral agreements per firm and potentially thousands of IM calls, collateral moves into segregated accounts, and other follow-on processing steps per day.
If OTC derivatives markets are to continue operating effectively as the buy side is integrated into the new regime, some margining processes built in the early stages—the triparty model, for instance—will need to be reformed in ways that add substantial scalability.
Besides incorporating functionality to accommodate the structural differences of buy-side entities, this year the industry must focus on creating efficient, cost-effective solutions for segregation and custody.
5) Leverage Infrastructure and Utility Solutions for Efficiencies.
There is good news! Some industry-driven solutions for segregation and market infrastructure are already in place and can spare firms from building their own.
The swaps margin-segregation service now under development at The Depository Trust Company (DTC) can manage the complexities of segregating collateral for a myriad of accounts. Leveraging DTC’s existing pledge service, this offering will enable DTC participants to pledge non-cash securities to and receive pledges from their counterparties in an efficient manner without building new bridges or connectivity.
And DTCC-Euroclear Global Collateral Limited’s (GlobalCollateral’s) Margin Transit Utility (MTU) streamlines collateral movement and settlement by automating delivery of instructions and reporting, including settlement confirmation from the receiver, which in turn reduces faxing and other manual touch points. MTU’s flexible, open architecture accommodates triparty as well as bilateral arrangements, including the capability to deliver instructions to segregated account structures. MTU also delivers real-time collateral updates post settlement to help users manage counterparty risks and the operational challenges of sourcing collateral for impending calls.
6) Start Now.
Although the first- and second-wave pioneers have paved the path for future IM implementation, firms still have plenty of work ahead as they reconfigure operations and retool liquidity and risk management for the new margining regime.
Several factors will contribute to their success in these efforts— including proper planning, collaboration across firms and service providers, leveraging new solutions, and utilizing industry infrastructures. It’s never too early to get started.