Step one: the ground work
Is my firm in-scope for initial margin, and if so, when?
The first task is to determine if your firm is in-scope for initial margin (IM). If in-scope, you must understand when you need to start exchanging IM. This depends on the structure of your group and the overall size of your derivatives portfolio.
To determine when you are subject to IM you must calculate your aggregate average notional amount (AANA) outstanding for all non-centrally cleared derivatives during the months of March, April and May each year. The frequency of your AANA calculation will vary depending on your location; in the US the calculation is done on a daily basis during the specified time period, whereas in the EU it is calculated monthly.
Regardless of where you are located, all non-cleared bilateral derivatives including physically settled foreign exchange (FX) forwards and swaps, as well as non-cleared intra-group transactions, should be included in the AANA.
For corporate groups, the above calculation must be performed and aggregated across all members of the group. It’s important to note that investment funds are generally considered distinct legal entities, as long as they are not collateralised by or otherwise guaranteed by other entities, funds or advisors for insolvency purposes.
Once you have done this calculation, refer to the chart to determine whether you exceed the threshold for any given year. If so, you will be subject to regulatory IM as of 1 September for the year in which the threshold is exceeded.
Step two: the practicalities
Which counterparties do I need to contact?
Once you have determined your firm’s compliance date it’s now time to confirm which counterparties you need to interact with.
You will have to be set up to exchange regulatory initial margin with all your counterparties who fall into any phase-in date up to and including your own.
All counterparties need to be contacted and you should work together to confirm the mutually effective dates, and also to determine which tri-party agent(s) you will each use to manage the IM segregation. Ensure you begin this discussion well in advance, as the custodial account control agreements and the credit support annex (CSAs) covering IM exchange take time to negotiate.
You must also consider that custodians often set deadlines well in advance of the annual 1 September date, by which time the account control agreements must be in place to ensure the custodian can operationally on-board them in advance of the IM exchange effective date. This insight is often mentioned by existing in-scope firms, so is an important “lesson learned”.
Step three: the number crunching
How do I calculate initial margin?
The regulation stipulates that you can calculate margin in two different ways: scheduled-based calculation and regulatory approved model-based calculation.
So far, the industry is united on using the International Swaps and Derivatives Association’s (ISDA) Standard Initial Margin Model (SIMM) to calculate IM. ISDA members worked together to develop this sensitivity-based approach to provide ease of calculation, transparency and effective dispute resolution. Risk factors and sensitivities form the inputs, while risk weights, correlations and aggregation formulae produce initial margin amounts.
As a starting point for the initial margin calculation, the model requires firms to calculate sensitivities in accordance with ISDA SIMM for all in-scope trades. This can be a significant data exercise in itself. Trades need to be identified as being in-scope, labelled correctly and appropriate sensitivities must be calculated for each trade. With an average of 20 sensitivities applicable to each trade and 150 or more sensitivities applicable for more exotic trades—the effort required for this step should not be underestimated and preparation is essential (see step four).
Firms must consider whether they will build internal processes to calculate the SIMM sensitivities themselves or whether they wish to have a vendor provide this service. Since the SIMM model will evolve, consideration should also be given to the ongoing internal development and testing required for model changes over time.
TriOptima’s centralised web-based service, triCalculate, can calculate trade sensitivities for you. Easy to integrate to and requiring limited data, SIMM inputs can be produced in-line with the latest SIMM model. Once you are able to calculate sensitivities the SIMM model can be applied to calculate the daily initial margin pledgor and secured amounts.
Once the task of calculating sensitivities has been completed, you then need to calculate your IM amount. To date, the majority of phase one, two and three firms have leveraged AcadiaSoft’s IM Exposure Manager to generate IM numbers. The AcadiaSoft service, which is powered by TriOptima, calculates and returns IM exposure from both the perspective of secured party (where you must collect IM) and pledgor party (where you must pay IM). The service also solves the significant challenge of reconciling each parties IM inputs, trades and sensitivities; allowing firms to investigate and resolve any differences in their respective IM calculations.
Step four: the analytics
What can I do in advance to ensure a smooth go-live?
Now you’re familiar with the post-go-live number crunching, it’s important to consider what should be done now to ensure a smooth go-live.
Firstly, you need to decide if your firm will use the schedule or SIMM calculation methodology pre-go-live as it needs to be agreed and communicated with your counterparties. triCalculate supports both methodologies and can help in the SIMM vs. schedule decision-making process with analytics on the effects of each methodology on your IM costs.
Secondly, you should understand what your initial margin cost will be before going live so you can manage expectations. It is difficult to predict your exact trading behaviour for trades eligible for initial margin, however, you can make an educated guess.
By working with triCalculate, you can identify a suitable portfolio for your first weeks, months, and years worth of trading and simulate your SIMM initial margin cost across all eligible relationships, allowing a more accurate depiction of what you can expect post-go-live.
Finally, it’s important to recognise where you stand with the thresholds for exchanging initial margin. You will have to actively exchange initial margin with all in-scope counterparties that exceed the threshold, however, you do not need to physically post initial margin until your IM amount breaches this threshold. Therefore, after go-live, you may have many in-scope counterparties that will not require the immediate posting of IM.
triCalculate helps many firms to generate analytics on their previous trading behaviour, allowing them to prioritise setting up IM agreements with counterparties that are likely to imminently breach the threshold.
Step five: the streamlining of the collateral process
How can I make the collateral management process more efficient?
Integrating the initial margin calculations with your collateral process, exchanging and agreeing on the collateral amounts with your counterparty and establishing a dispute resolution workflow are the next steps you need to consider.
With margin notification times moving earlier in the business day, and a need to agree on margin calls ahead of custodian cut-off times, it is crucial to establish an efficient workflow process for exchanging and agreeing on margin calls with your counterparty. triResolve Margin, TriOptima’s collateral management solution, automatically captures IM amounts from the AcadiaSoft IM Exposure Manager—or allows upload from other sources—where they can be processed alongside those for variation margin on a single platform. All calls can be exchanged in real-time using MarginSphere—AcadiaSoft’s Hub electronic messaging service.
Perhaps the biggest challenge for the industry is having a dispute resolution method in place with counterparts for initial margin amounts. Due to the way that SIMM is structured, disagreements will arise when you provide different inputs. The sheer volume of sensitive data will likely mean you have a large number of small differences. AcadiaSoft’s IM Exposure Manager allows you to pinpoint meaningful differences, enabling you and your counterparty to work together to resolve them and minimise your disputes. This is increasingly important as this is now a regulated part of the market.
To achieve full compliance with ease, leveraging existing out-of-the-box industry tools to reconcile your inputs and automate the process is highly recommended.
Step six: the governance
How can I keep pace with the evolving SIMM model and demonstrate my compliance?
Once you are set-up with your SIMM initial margin daily workflow, you then need to consider your ongoing commitment to your SIMM governance.
ISDA carry out revisions to the SIMM model at least once a year. As a SIMM user, you will be obligated to keep up-to-date with an implementation of the latest SIMM model. If you are using TriOptima’s solution, this obligation is taken care of for you.
Further, as a SIMM user, it’s likely you’ll be required by ISDA or your regulator to demonstrate the suitability of the SIMM model for your trading portfolio. This can be achieved through backtesting and benchmarking.
triCalculate supports two methods of backtesting. With a simple trade file submission triCalculate can run backtesting for you and generate the respective reports in the format required by ISDA.
triCalculate’s backtesting approaches:
1. Comparison of actual portfolio level PnL moves with IM generated from SIMM either a 10-day SIMM to 10-day actual PnL moves, or one-day SIMM to one-day actual PnL moves.
2. 1+3 Standard: To assess whether a spike in risk factor volatility causes a SIMM margin coverage shortfall under the “1+3 Standard,” backtesting is needed that reflects one year of stress and three years of most recent continuous portfolio market conditions.
Step seven: bringing it all together
How can I calculate my inputs, manage my margin calls and resolve my disputes?
TriOptima has helped many phase one, two and three firms meet their IM requirements. We understand the complexities and are best placed to help you overcome them with our seamless solution that requires only one simple trade file.
