September 2016 saw the introduction, following globally coordinated efforts by regulators, of the first phase of Basel Committee on Banking Supervision (BCBS) International Organization of Securities Commissions (IOSCO) initial margin (IM) requirements for non-centrally cleared derivatives.
The opening wave of compliance affected only the largest financial institutions but now far smaller companies are finding themselves caught: phase 4 firms are set to come into scope in September 2019, while the final tranche of organisations (phase 5) is due to comply in September 2020. Phase 5 will have a particularly great impact on the buy-side, with as many as 1000 entities brought within the IM regime.
Compliance with BCBS IOSCO IM standards for non-centrally cleared derivatives creates a number of hurdles for firms: both parties to a deal must exchange IM, with IM being calculated on a daily basis, at a netting set level, and then posted to a segregated account.
Not surprisingly, small organisations falling within Phase 5 are particularly keen to escape the reach of the incoming IM rules. To this end, a group of trade associations have approached global regulators, on behalf of affected firms, petitioning for the Aggregate Average Notional Amount (AANA) threshold at which counterparties must comply to be raised. It is not yet clear what the response of the regulators will be but companies should not assume they will be let off the hook where IM obligations are concerned.
If phase 5 firms are not able to claim exemption, they will have to meet the new IM requirements. But how should they best proceed? Manual processes are unlikely to provide a satisfactory way forward, and so firms will need to look at introducing greater levels of automation. With compliance deadlines looming, some companies may choose to opt for a basic collateral management solution, considering it the quickest and cheapest route to compliance. Yet a mature system could, in the long term, provide a far more cost-effective answer, and one which better equips firms to deal with future change.
The question of future regulatory change is especially worth keeping in mind. To date, regulators have worked in unison on the creation of margin rules for uncleared derivatives. Divisions have arisen, however, in relation to Brexit, that could result in regulators distancing themselves from each other. Typically, basic collateral management systems have been designed to answer the needs of a harmonised regulatory world. In contrast, a sophisticated solution will enable financial institutions to handle the complexities that a diverging regulatory landscape could present. More contentiously, should firms choose to arbitrage the opportunities such a landscape presents, a specialist system will support them most effectively to do so. A system that is proven to cope with the complexity inherent in IM compliance is SmartStream’s TLM Collateral Management. The solution allows a high degree of automation, reducing the effort associated with moving collateral between counterparties. It also takes an exception-based approach, enabling financial institutions to better accommodate the growth in margin calls IM rules are likely to stimulate.
SmartStream’s TLM Collateral Management system has been installed by a number of tier 1 and 2 financial institutions. Mutualised knowledge from these projects has been incorporated into the design of the solution and firms preparing for IM regulation can take advantage of this shared experience.
Fears over cost and long implementation times may dissuade some financial institutions from considering a sophisticated solution. TLM Collateral Management can, however, be deployed on demand. Firms are able to benefit from its “tier 1 DNA” without the need for either a lengthy installation phase or for heavy investment in infrastructure, meaning that the solution can be adopted easily and cost-effectively. Regular software updates also ensure that maintenance costs are minimised.
One significant advantage offered by TLM Collateral Management is the fact that it does not commingle data. This is an important security consideration, for where a firm’s proprietary data is commingled it could—in the event of a breach—become apparent to competitors, leaving a company exposed to potential financial or reputational risks.
Underpinning the quality of TLM Collateral Management is the high level of investment made by SmartStream in its solutions. At present, some 25 percent of SmartStream’s revenue is ploughed back into research and development. SmartStream’s focus on investing in and developing its technology is also reflected in the partnerships it has created with a number of industry specialists.
One such partnership is a recent agreement with Cassini Systems, which will see the integration of Cassini’s analytics platform with TLM Collateral Management to provide the International Swaps and Derivatives Association (ISDA) Standard Initial Margin Model (SIMM) calculation as well as risk sensitivity generation. A similar collaboration with Numerix will provide sensitivity and SIMM calculation. In both cases SIMM results will be retrieved by TLM Collateral Management and then used in IM Margin calculations. Other industry partnerships include an integration, at a tier 1 bank, of TLM Collateral Management and AcadiaSoft’s software services, in order to help deliver margin call automation and straight-through processing.
Finally, TLM Collateral Management is just one part of SmartStream’s suite of software solutions. Financial institutions are looking to expand automation projects beyond collateral management into other, linked areas, such as cash and liquidity management, in order to pull together different parts of their businesses. SmartStream’s range of solutions can assist them to do this, as was evidenced by a recent implementation of TLM Collateral Management at a major UK bank. Following the project, the bank—pleased with the quality and testing of the software, plus the consistent, within budget delivery of the project—is now looking to expand into further TLM solutions.
In conclusion, the pressing need to fulfil IM obligations, coupled with concerns over cost, may lead some institutions to opt for the most basic of collateral management solutions. Yet once the initial rush to comply has passed, other considerations will begin to take over, including questions over cost-effectiveness, efficiency, consolidation, risk, the ability to adjust to future business and regulatory change. Less sophisticated systems could then show their limitations and firms may begin to ask whether small has really turned out to be beautiful, after all.
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