Re-papering over the cracks
08 Jun 2022
Brian Bollen outlines the rulings behind Phase 6 of the UMR. Who in the industry is well prepared ahead of the September implementation date, and who is still lagging dangerously behind?
Image: alexandr_bognat/stock.adobe.com
Re-paper. This word featured so often in a recent conversation that at one point this writer felt they were listening to a script read-through for a television property refurbishment programme.
He was in fact talking to Shaun Murray, CEO of the specialist consultancy firm Margin Reform. The subject under discussion was not the refreshment of internal domestic design, but the readiness of financial markets for Phase 6 of Uncleared Margin Rules (UMR), which is currently due to begin on 1 September this year.
This will extend the requirement to comply with UMR to firms whose total notional exposure (measured on a group basis) reaches €8 billion, although if counterparty relationships fall below a €50 million initial margin (IM) threshold, they will continue to be exempt — for now.
“If you do not reach that threshold, you do not have to re-paper,” Murray states. “But if you think you will breach it, then you should either be working on it, or have in place a soft trigger to threshold monitor and commence re-papering when you hit that point. Should you breach the threshold without the re-papering completed, you will have to stop trading and get back below the threshold.”
It almost goes without saying that there is software available to alert firms pre-trade to a potential breach. “You do not want to be using Excel,” Murray cautions.
Over the course of the last few months, many vendors have been doing much more than utilising Excel to ready their clients for Phase 6 of the UMR. For one, SmartStream Technologies has launched Eligibility API, a new solution for faster collateral management optimisation.
Eligibility API is a platform for clients to receive eligibility information contained within collateral agreements, such as credit support annex, global master repurchase agreements and overseas securities lenders’ agreements, for both pre- and post-trade collateral optimisation.
In April, BNP Paribas Securities Services announced its collaboration with DTCC to provide a solution which aids its clients in preparing for Phase 6 of the UMR. The collaboration will see BNP Paribas’ Triparty Collateral Management solution connect with DTCC’s Margin Transit Utility service for Phase 6 compliance — in an effort to reduce operational complexity and risk for margin call processing.
BNP Paribas Securities Services has also added IHS Markit as an IM calculation source to its existing service for clients that are in-scope for UMR in derivatives markets. IHS Markit provides sensitivities fed into BNP Paribas’ middle-office platform through a Common Risk Interchange Format file, to perform IM calculations and reconciliation.
The right papers
However, the re-papering which Murray repeatedly referenced is the process by which would-be derivatives traders ensure that their documentation is complete, consistent and coherent.
The typical process can take up to one year from start to finish with people who know and understand the regulations, Murray explains, meaning that anyone who is not already compliant with the regulations and needs to re-paper is clearly already running late. “Not everyone will be ready,” he warns. “There will always be a tail of clients where threshold monitoring is acceptable, for now.”
While re-papering is the largest issue in this sector, others do need to be taken into consideration. Murray identifies cost as one such consideration. “If you think about collateral historically, costs have gone up. Everyone active on the buy-side has to be aware of the regulations and how they affect ownership.”
He specifically cites back testing, benchmarking, auditing, risk management and the existence of 13 or 14 other jurisdictions — with their own version of UMR — as other considerations.
“Regulatory requirements are not going to go away,” Murray goes on. “People have to get up to speed with collateral management and how it works, unless they want to fall foul of regulatory monitors.”
A number of other industry specialists volunteered their help in the preparation of this article, amongst them Julie Mostefai, global product manager for over-the-counter (OTC) and collateral services at BNP Paribas Securities Services.
“This is a very active and very special period for our industry, being the final stage of an implementation process that began in 2016 and has been delayed by the outbreak of COVID-19,” she says.
“Around 1,000 firms will be among those newly affected, mainly on the buy-side, and they are by definition less experienced and less familiar with the topic than the firms caught by the previous phases, and generally less equipped to deal with it.”
Mostefai adds: “Consequently, a significant number of the new firms are looking to outsource the process to asset services providers where they lack the knowledge, experience and technology to calculate margin requirements.”
However, on the other hand, she says: “The €50 million threshold is very welcome for Phases 5 and 6 in-scope firms, as it allows a bit of relief — granting them further time to demonstrate full compliance instead of being prevented from trading.”
For firms to determine if they are in scope of the UMR, they must first calculate their Average Aggregate Notional Amount (AANA).
To calculate a firm’s AANA is to sum the total outstanding amount of non-cleared derivative positions during the prescribed observation period on a gross notional basis. All instruments are to be considered when calculating a firm’s AANA.
Once a firm determines if it is in scope, it should begin the process of disclosing to its counterparty groups.
Phil Slavin, CEO of Taskize, a financial technology firm that helps financial institutions reduce the amount of time firms spend disputing margin calls, comments: “Those close to the threshold of the €8 billion AANA threshold, particularly those with heavy commodity exposure, will have their hands full over the next 100 days from an operational perspective in preparing for Wave 6 of the UMR regulation.”
He identifies the misalignment of margin calculation models as a key reason for disputes in exchanging margin.
In many cases, hedge funds will be using a custom risk model for margin calculation, or one from an external provider, if they are resource-constrained, which will very often be different from the model being used by their counterparty.
“As a result, disputes between parties will arise and operations will fall back to using email for getting to a resolution,” Slavin adds.
“When Phase 6 comes into effect, the expected increase in volume of margin disputes and the costs associated will further illustrate the shortcomings of email for post-trade operations.
“Those affected need to put in place solutions to resolve these disputes more efficiently, ensuring there is effective collaboration across global financial operations staff.”
Refining the edges
Phase 6, perhaps more than its predecessors, will be pulling in numerous investment managers — many of whom will be trading on behalf of clients and thus facing reduced regulatory thresholds, surmises Neil Murphy, business manager at TriOptima, OSTTRA.
“While some will have pretty vanilla portfolios, the more sophisticated quant hedge funds will possess more exotic portfolios with associated market data requirements creating new operational challenges,” Murphy adds.
“Getting hold of the relevant market data, identifying in-scope trades and correctly assigning trades to relevant risk buckets in a timely fashion is key to these firms calculating IM.”
For its part, CME Group sent out a note with exactly 100 days to go in the final countdown, advising that an all-time record number of market participants are holding large open interest positions in foreign exchange (FX) futures, while interest in equity futures is growing strongly.
“While certain FX instruments, such as forwards, are not in-scope products for UMR, they do contribute to the notional driving the qualification,” outlines Paul Houston, global head of FX products at CME Group.
“This is a key factor as to why more asset managers are using FX futures as a replacement for some of their OTC FX forward exposure, as they do not count towards the rules. The final phase of UMR, where the threshold reduces to €8 billion AANA threshold billion, will see many more firms impacted and this activity has increased correspondingly.”
“UMR has further increased the appeal of listed futures,” adds Paul Woolman, executive director of equity products at CME Group. “The capital-efficient, transparent, liquid nature of these products, along with their ability to help clients mitigate counterparty risk, has led to the adoption of traditional futures.”
“Increased demand for listed OTC alternatives, such as adjusted interest rates total return futures, dividend futures, and sector futures, shows that preparations are in full swing 100 days out from the deadline.”
Speaking specifically of securities lending, Adrian Dale, head of regulation, digital and market practice at the International Securities Lending Association, says: “Securities lending is a valuable mechanism for the efficient management of assets and collateral that, by extension, may assist with UMR obligations, especially for those firms in Waves 5 and 6 of the margin rules.”
“However, and while UMR in itself does not drive any specific documentation or industry practice change within our market, many firms have expressed the view that UMR is increasing the use of securities lending for the specific purpose complying with these obligations,” he adds.
What, then, happens next? We turn to Amy Caruso, head of collateral initiatives at the International Swaps and Derivatives Association for a conclusion. “The expected volume in this phase is higher than all the previous phases combined. Everyone needs to be operationally ready,” she highlights.
“The tail of Phase 6 will go on into 2023, but will not be the end of the story. It will go on for perpetuity. There will be a need for continual monitoring.
“Phase 6 is not a one-and-done situation — UMR will become an embedded part of a firm’s annual review processes going forward as the industry prepares for a new normal.”
He was in fact talking to Shaun Murray, CEO of the specialist consultancy firm Margin Reform. The subject under discussion was not the refreshment of internal domestic design, but the readiness of financial markets for Phase 6 of Uncleared Margin Rules (UMR), which is currently due to begin on 1 September this year.
This will extend the requirement to comply with UMR to firms whose total notional exposure (measured on a group basis) reaches €8 billion, although if counterparty relationships fall below a €50 million initial margin (IM) threshold, they will continue to be exempt — for now.
“If you do not reach that threshold, you do not have to re-paper,” Murray states. “But if you think you will breach it, then you should either be working on it, or have in place a soft trigger to threshold monitor and commence re-papering when you hit that point. Should you breach the threshold without the re-papering completed, you will have to stop trading and get back below the threshold.”
It almost goes without saying that there is software available to alert firms pre-trade to a potential breach. “You do not want to be using Excel,” Murray cautions.
Over the course of the last few months, many vendors have been doing much more than utilising Excel to ready their clients for Phase 6 of the UMR. For one, SmartStream Technologies has launched Eligibility API, a new solution for faster collateral management optimisation.
Eligibility API is a platform for clients to receive eligibility information contained within collateral agreements, such as credit support annex, global master repurchase agreements and overseas securities lenders’ agreements, for both pre- and post-trade collateral optimisation.
In April, BNP Paribas Securities Services announced its collaboration with DTCC to provide a solution which aids its clients in preparing for Phase 6 of the UMR. The collaboration will see BNP Paribas’ Triparty Collateral Management solution connect with DTCC’s Margin Transit Utility service for Phase 6 compliance — in an effort to reduce operational complexity and risk for margin call processing.
BNP Paribas Securities Services has also added IHS Markit as an IM calculation source to its existing service for clients that are in-scope for UMR in derivatives markets. IHS Markit provides sensitivities fed into BNP Paribas’ middle-office platform through a Common Risk Interchange Format file, to perform IM calculations and reconciliation.
The right papers
However, the re-papering which Murray repeatedly referenced is the process by which would-be derivatives traders ensure that their documentation is complete, consistent and coherent.
The typical process can take up to one year from start to finish with people who know and understand the regulations, Murray explains, meaning that anyone who is not already compliant with the regulations and needs to re-paper is clearly already running late. “Not everyone will be ready,” he warns. “There will always be a tail of clients where threshold monitoring is acceptable, for now.”
While re-papering is the largest issue in this sector, others do need to be taken into consideration. Murray identifies cost as one such consideration. “If you think about collateral historically, costs have gone up. Everyone active on the buy-side has to be aware of the regulations and how they affect ownership.”
He specifically cites back testing, benchmarking, auditing, risk management and the existence of 13 or 14 other jurisdictions — with their own version of UMR — as other considerations.
“Regulatory requirements are not going to go away,” Murray goes on. “People have to get up to speed with collateral management and how it works, unless they want to fall foul of regulatory monitors.”
A number of other industry specialists volunteered their help in the preparation of this article, amongst them Julie Mostefai, global product manager for over-the-counter (OTC) and collateral services at BNP Paribas Securities Services.
“This is a very active and very special period for our industry, being the final stage of an implementation process that began in 2016 and has been delayed by the outbreak of COVID-19,” she says.
“Around 1,000 firms will be among those newly affected, mainly on the buy-side, and they are by definition less experienced and less familiar with the topic than the firms caught by the previous phases, and generally less equipped to deal with it.”
Mostefai adds: “Consequently, a significant number of the new firms are looking to outsource the process to asset services providers where they lack the knowledge, experience and technology to calculate margin requirements.”
However, on the other hand, she says: “The €50 million threshold is very welcome for Phases 5 and 6 in-scope firms, as it allows a bit of relief — granting them further time to demonstrate full compliance instead of being prevented from trading.”
For firms to determine if they are in scope of the UMR, they must first calculate their Average Aggregate Notional Amount (AANA).
To calculate a firm’s AANA is to sum the total outstanding amount of non-cleared derivative positions during the prescribed observation period on a gross notional basis. All instruments are to be considered when calculating a firm’s AANA.
Once a firm determines if it is in scope, it should begin the process of disclosing to its counterparty groups.
Phil Slavin, CEO of Taskize, a financial technology firm that helps financial institutions reduce the amount of time firms spend disputing margin calls, comments: “Those close to the threshold of the €8 billion AANA threshold, particularly those with heavy commodity exposure, will have their hands full over the next 100 days from an operational perspective in preparing for Wave 6 of the UMR regulation.”
He identifies the misalignment of margin calculation models as a key reason for disputes in exchanging margin.
In many cases, hedge funds will be using a custom risk model for margin calculation, or one from an external provider, if they are resource-constrained, which will very often be different from the model being used by their counterparty.
“As a result, disputes between parties will arise and operations will fall back to using email for getting to a resolution,” Slavin adds.
“When Phase 6 comes into effect, the expected increase in volume of margin disputes and the costs associated will further illustrate the shortcomings of email for post-trade operations.
“Those affected need to put in place solutions to resolve these disputes more efficiently, ensuring there is effective collaboration across global financial operations staff.”
Refining the edges
Phase 6, perhaps more than its predecessors, will be pulling in numerous investment managers — many of whom will be trading on behalf of clients and thus facing reduced regulatory thresholds, surmises Neil Murphy, business manager at TriOptima, OSTTRA.
“While some will have pretty vanilla portfolios, the more sophisticated quant hedge funds will possess more exotic portfolios with associated market data requirements creating new operational challenges,” Murphy adds.
“Getting hold of the relevant market data, identifying in-scope trades and correctly assigning trades to relevant risk buckets in a timely fashion is key to these firms calculating IM.”
For its part, CME Group sent out a note with exactly 100 days to go in the final countdown, advising that an all-time record number of market participants are holding large open interest positions in foreign exchange (FX) futures, while interest in equity futures is growing strongly.
“While certain FX instruments, such as forwards, are not in-scope products for UMR, they do contribute to the notional driving the qualification,” outlines Paul Houston, global head of FX products at CME Group.
“This is a key factor as to why more asset managers are using FX futures as a replacement for some of their OTC FX forward exposure, as they do not count towards the rules. The final phase of UMR, where the threshold reduces to €8 billion AANA threshold billion, will see many more firms impacted and this activity has increased correspondingly.”
“UMR has further increased the appeal of listed futures,” adds Paul Woolman, executive director of equity products at CME Group. “The capital-efficient, transparent, liquid nature of these products, along with their ability to help clients mitigate counterparty risk, has led to the adoption of traditional futures.”
“Increased demand for listed OTC alternatives, such as adjusted interest rates total return futures, dividend futures, and sector futures, shows that preparations are in full swing 100 days out from the deadline.”
Speaking specifically of securities lending, Adrian Dale, head of regulation, digital and market practice at the International Securities Lending Association, says: “Securities lending is a valuable mechanism for the efficient management of assets and collateral that, by extension, may assist with UMR obligations, especially for those firms in Waves 5 and 6 of the margin rules.”
“However, and while UMR in itself does not drive any specific documentation or industry practice change within our market, many firms have expressed the view that UMR is increasing the use of securities lending for the specific purpose complying with these obligations,” he adds.
What, then, happens next? We turn to Amy Caruso, head of collateral initiatives at the International Swaps and Derivatives Association for a conclusion. “The expected volume in this phase is higher than all the previous phases combined. Everyone needs to be operationally ready,” she highlights.
“The tail of Phase 6 will go on into 2023, but will not be the end of the story. It will go on for perpetuity. There will be a need for continual monitoring.
“Phase 6 is not a one-and-done situation — UMR will become an embedded part of a firm’s annual review processes going forward as the industry prepares for a new normal.”
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