Uncleared Margin Rules (UMR) have been put in place globally to mitigate credit exposures and reduce systemic risk in derivative markets
Firms are required to calculate initial and variation margin requirements on a daily basis
Daily initial margin requirements must be supported by both the posting AND receiving of collateral which must be held in segregated bankruptcy remote custodial arrangements
Costs associated with UMR compliance may affect the business models and investment strategies of newly in scope firms
Phases 5 and 6 of UMR scheduled for September 2020 and September 2021 could bring into scope over 1,000 firms trading under nearly 10,000 legal agreements, requiring the establishment of up to 20,000 custodial arrangements
Smaller firms may not have the experience, processes and technology to implement and manage daily margin and collateral processes
Larger firms may not have the scale and efficiency to cope with the increased numbers of clients caught by phases 5 and 6
Industry estimates based on the experience from the first four phases suggest implementation could take in excess of a year
And given pressure on organisations to deliver other reform such as LIBOR and FRTB, competition for scarce resources amongst firms in phases 5 and 6 could create risks to compliance.
Background – Uncleared Margin Rules
As a result of the financial crisis, in September 2009 the G20 agreed to introduce a range of regulations to make financial markets safer, fairer, more efficient and more transparent.
In 2011 the BCBS and IOSCO were called upon to develop consistent global standards for the margining of non-centrally cleared derivatives with the dual intentions of reducing systemic risk and promoting central clearing.
The resulting policy framework published in 2015 has been enacted into global legislation requiring derivative trading to be supported by the exchange of variation and initial margin. The legislation has been phased in based upon firms’ aggregate average notional amount (AANA) of non-centrally cleared derivatives.
The first four phases up to September 2019 have affected a relatively small number of dealers and large, well-resourced financial firms and asset managers. The introduction into force of Phase 5 in September 2020 and the additional Phase 6 due for September 2021 is now on a different scale – both in volume of clients impacted and the sheer volume of effort required for repapering and operational readiness. And for many organisations, the operational requirements around calculation, monitoring and active segregation of non-cash collateral to support compliance will require new systems, processes and custodial relationships
In addition, industry estimates suggest that the renegotiation of existing ISDA Master Agreements and Credit Support Annexes might take up to 3 months, and that the KYC due diligence and onboarding requirements of custodians potentially taking up to a year. Given the numbers of market participants looking for similar solutions in the same short time period, these estimates are not unreasonable.
The sheer scale of the numbers of firms caught by the final phases is likely to have an impact on the capabilities of dealers, custodians, vendors and service providers to assist firms in meeting their obligations in a timely and efficient manner. And though for firms within the newly introduce Phase 6 may feel they have longer to comply (or think they may never reach the newly incorporate $50m IM threshold), the spirit of the regulatory recommendations within July 2019 to provide relief was recognition that the industry hadn’t time to prepare. So, delaying your planning and prioritising other work will in all likelihood lead to failure – as risk potentially exacerbated when viewed against the competing priority of LIBOR remediation due for 2021, which will lead to a concentration of pressure upon similar teams and resources responsible for delivering compliance.
Without the ability to both call and receive collateral to support initial margin calculations, parties will no longer be able to trade uncleared OTC derivatives once they have passed the margin thresholds set by the regulators.
So understanding the implications of the phase in process for your business will be key to successful operational readiness.
4 C’s for UMR Compliance
Whilst the intentions, principles and schedules for the implementation of the Uncleared Margin Rules are internationally synchronised and arguably relatively straightforward to understand, the detail of the global legislation introduces a high degree of complexity in interpreting and implementing firms’ compliance solutions.
This complexity is multiplied for firms with multi-layered, multi-jurisdictional corporate, group or fund structures. Similarly, engagement with multiple counterparts is likely to lead to multiple different detailed requirements.
The adoption of UMR solutions will introduce new costs to firms, not only in terms of the cost of implementing new agreements, processes and technology, but also the ongoing costs to the business going forward.
Firms should undertake a broad assessment of the impact of costs on their business model. Such analysis should consider the effects on risk and financial resource management, the application of pre- and post-trade decision making and the incremental costs for custody and settlement.
Uncleared Margin Rules impose ongoing control requirements on firms. The implementation of margin calculation models is subject to regulatory approval. Such approval requires amongst other things the demonstration of ongoing maintenance and back testing of margin models.
Trades, portfolios and valuations are subject to reconciliation requirements. Margin and collateral management processes are subject to eligibility and dispute resolution requirements. Firms must implement clear ownership and governance of these roles as part of their target operating model.
Smaller firms may have fewer resources to analyse, design, implement and run compliance solutions. Larger firms may have experience and resources based on the implementation of previous phases of UMR, but the prospect of negotiating, onboarding and testing with a proportion of around 1,000 newly in scope firms by September 2020 and then September 2021 may prove challenging.
Organisations should be considering not only the resourcing required to execute on compliance but also the ongoing impact the obligations drive in terms of workload. Understanding how to support and scale the operating model to satisfy the new obligations is a critical success factor for safeguarding ongoing compliance.
Contact Ascendant Strategy to understand how we can help you navigate the complexity associated with compliance and ongoing management
Authored by Mark Croxon, Thamesbench Ltd, for Ascendant Strategy Ltd
 G20, Pittsburgh summit declaration, http://www.g20.utoronto.ca/2009/2009communique0925.html
 G20, Cannes summit final declaration, http://www.g20.utoronto.ca/2011/2011-cannes-declaration-111104-en.html
 BIS/ISOCO, final policy framework, https://www.bis.org/bcbs/publ/d317.pdf
 European Commission, https://eur-lex.europa.eu/legal-content/EN/TXT/PDF/?uri=CELEX:32016R2251&from=EN
US Prudential Regulators, https://www.govinfo.gov/content/pkg/FR-2015-11-30/pdf/2015-28671.pdf
NB The SEC reopened its comment period on margin rules for Security Based Swap Dealers in Oct 2018: https://www.sec.gov/rules/proposed/2018/34-84409.pdf