Uncleared margin rules: 10 actions to help firms prepare

This is not the time to slow down, but an opportunity to reassess and make sure you meet your long-term needs.

The uncleared margin rules (UMR) present an opportunity for the industry to implement scalable and robust collateral management processes as well as deliver against regulatory requirements. With the Basel Committee of Banking Supervision (BCBS) and International Organization of Securities Commissions (IOSCO) announcement on April 3, 2020, revising their final policy framework to include a further one-year delay for Phase 5 and Phase 6 firms, there is an opportunity for firms to step back and make certain that they are approaching this opportunity strategically.

While the BCBS-IOSCO revision needs to be adopted by local jurisdictional regulators, this revision is a welcome relief for the industry, currently dealing with significant spikes in margin call volumes and valuation disputes driven by COVID-19 market volatility. We also observe that many organizations were behind schedule for both Phase 5 and 6 compliance, some of whom had made tactical over strategic selections because of time constraints. 

Firms should use this opportunity to look holistically at their collateral management operations requirements and invest in the right solutions and partners to strategically meet their infrastructure needs.

It is imperative that all Phase 5 and 6 firms have programs in place to accelerate readiness and work with their dealers and vendors on implementing appropriate strategic solutions. This will make certain that the impact of the inevitable bottleneck of onboarding is minimized and an appropriate long-term capability delivered.

From our work supporting over half of the industry that is operating under the UMR framework today, we have identified 10 actions that firms subject to the regulations need to be progressing to make certain they are ready for compliance. As this is a cross-functional regulatory framework, preparation starts with establishing an enterprise governance structure and conducting an impact assessment across the organization. As part of these programs, detailed plans and cross-functional roles and responsibilities must be defined to support regulatory compliance. 

Highlighted below are the top 10 activities firms should focus on to initiate and prepare for UMR compliance:

1. Establish UMR program and governance framework

• Formulate a cross-functional UMR compliance plan for implementation.
• Define executive in charge and program ownership across key stakeholders responsible for key functional areas (legal, operations, risk, etc.).
• Establish timelines for key steps and requirements, including end-to-end industry testing.

2. Perform AANA calculation and scoping assessment

• Perform AANA calculation and, if applicable, communicate results specifically focusing on funds close to IM thresholds.
• Re-perform AANA, on an ongoing basis, as needed to confirm the appropriate compliance timeline.
• Understand entity and fund structure, parent ownership of funds, and type of accounts to determine scope and applicability.
• Self-disclose to relevant counterparties and engage early with clients to accelerate implementation and onboarding.

3. Determine appropriate operating model from a people, process and technology perspective

• Determine whether to build components in house or leverage external vendors, in consideration of the following: 
  • Current state infrastructure capabilities and integration of systems.
  • Maturity of current workflow processes (i.e., manual vs. automated).
  • Data availability and quality.
  • Size of derivatives portfolios across entities and expected workflow impacts.
  • Evaluate third-party vendors and determine suitable option(s) given firm’s business strategy, infrastructure and portfolio.
• Evaluate third-party vendors and determine suitable option(s) given firm’s business strategy, infrastructure and portfolio:
  • Asset servicers and outsource providers: Collateral management outsource providers perform valuation services, IM threshold determinations and IM calculations. In some cases, providers can also help firms identify in-scope funds to support the AANA calculation. Additionally, firms with manually intensive processes may consider outsourcing their collateral operational processes. 
  • Vendor software providers: Firms can also leverage vendor software and technology platforms as either added on to existing infrastructure or as net-new to enhance current collateral management capabilities. Vendor solutions can be used specifically for IM calculations or can be implemented more broadly to support collateral operations workflow.

4. Negotiate trading documentation with defined in-scope population

• Establish a negotiation road map early, including an evaluation of your current state, such as the location of documentation, quality of contract metadata in the system of record, and the capacity of the legal negotiation team.
• Prioritize counterparties for negotiation of IM documentation and account setup, based on the importance of each account and trading relationship. 
• Determine the custodians you will leverage that best suit your business, the custodians you anticipate your counterparties to use and the timetable each custodian will require to set up independent collateral accounts.
• Establish IM documentation playbook, outlining preferences, elections and fallback approaches, and an escalation and approval process.
• Prepare for synchronization with the operational infrastructure teams, including a path to provide newly agreed collateral terms to collateral management, updating the system of record, allocation of IM threshold and custodial documentation terms aligned with operational capacity.

5. Determine IM calculation methodology

• Determine IM calculation methodology (e.g., risk-based model (SIMM), grid-based approach) in consideration of OTC derivative portfolio, business strategy, model governance (if applicable – e.g., backtesting) and regulatory process (if applicable).
• Determine whether to build the IM calculation, or components thereof (e.g., sensitivity generation, Common Risk Interchange Format (CRIF)), in-house or leverage vendor IM solutions.
• If electing to outsource to a vendor, review vendor solutions to determine suitability for your portfolio (i.e., portfolio composition) and build internal governance processes (e.g., ongoing reconciliations, testing) as appropriate (see item 8).
• Determine how to allocate the group-level $50m threshold across funds and entities that transact with a common counterparty.

6. Implement changes to operational infrastructure

• Assess scalability of existing infrastructure and maturity of current processes to support increased complexity and volume.
• Implement collateral operational processes to support daily exchange of IM, risk and dispute management, connectivity to custodians, and internal and external data feeds.
• Assess current operating model and determine opportunities for enhancements and potential vendor support (refer to item 10 for further detail).
• Establish IM reporting requirements for regulatory and internal downstream (credit, risk, compliance and finance) purposes.

7. Establish custody and segregation model and structure

• Determine custody and segregation model to adopt between triparty or third party.
• Initiate negotiation of Account Control Agreements (ACA) and other required custodian documentation.
• Build connectivity with current custodians as well as dealers’ custodians with appropriate feeds for daily movement of IM collateral required value (RQV).
• Engage in conversations with custodians to determine suitability and confirm capacity, given the expected number of new in-scope entities, business strategy and required geographical support.

8. Obtain model approval/testing (if applicable)

• For regulated entities, implementation of required regulatory approval from the firm’s prudential regulator (depending on the regulatory jurisdiction).
• Provide relevant documentation to regulators for review in advance of and during the on-site model exam.
• Determine the appropriate data sources for risk sensitivities, risk bucket mapping and P/L generation for backtesting.

9. Assess opportunities for collateral optimization

• Develop optimization strategy given range of eligible collateral for regulatory initial opportunity.
• Confirm counterparty appetite and custodian capability to support collateral optimization approach.
• Leverage analytic tools for what-if scenarios to help determine optimal trading decisioning.

10. Plan for post-compliance and beyond

• Firms need to evaluate their initial program and business decisions, including scalability of their internal infrastructure for upcoming phases, geographical coverage of custodians, custody model, IM calculation method and in-scope entities.
• Firms need to embed ongoing monitoring processes to check for compliance beyond the current compliance timelines (e.g., ongoing AANA monitoring, threshold monitoring, building feeds to new product approval processes).