Amid the frenzied and uncertain landscape of the last two years, one telling insight stands out. Automation across the trade lifecycle brings the required speed, agility and resilience to ride through volatility. With the spate of new and revised regulations continuing to descend upon the industry, the value of automation cannot be further overemphasized to promote compliance.
More specifically, the last stretch of instituting BCBS-IOSCO uncleared margin rules (UMR) – Phase 6 – which take effect on 1 September 2022 will impact in scope buy-side firms in Asia-Pacific with an aggregated average notional amount (AANA) of US$8 billion and require them to exchange initial margin (IM) with their counterparties.
Aimed at reducing counterparty risk and improving collateral management, UMR – which began implementation in 2016 – has highlighted the importance of automation. At the same time, the challenges of managing IM demands were further amplified during the pandemic where volumes spiked significantly. If not managed efficiently, margin processes and workflows, as resource intensive as they are, could lead to a compliance breach when the required margin is not posted in accordance with the governing contract.
As a result, firms must work now to ensure readiness on all fronts – operational, legal, documentation. Let’s take a closer look at Phase 6 and how it will impact in scope firms.
Tackling Phase 6
With the reduction in AANA to US$8 billion, Phase 6 will require more firms and their underlying clients to meet UMR requirements. It is estimated that the final phase of UMR will impact approximately 700 to 1,200 counterparty relationships across Asia-Pacific and globally.
To gain a better understanding of the immediate priorities for Phase 6, Depository Trust & Clearing Corporation (DTCC) interviewed 26 buy-side firms in Asia-Pacific from December 2021 to February 2022. Our interview with firms revealed that nearly half (46%) of firms are still preparing for Phase 6 while another 12% have not commenced work. Time is of key essence in this instance, to avoid penalties for non-compliance.
Key findings from the interviews highlighted that 31% of firms are more concerned about the operational impact of the rules as opposed to the economic impact at 19%. In support of this, 31% of firms are now enhancing their collateral management processes while 42% or four out of 10 firms are conducting reviews.
These findings underscored an important aspect of UMR preparation: a thorough review of a firm’s existing business and operational environment is needed to identify current limitations and operational risks, including areas where manual processes are leveraged. The impact analysis should include operational and information technology adjustments necessary to scale up operations, eliminate errors, ensure operational resilience and promote compliance.
Understanding logistical impact
There are also legal and documentation aspects that must be addressed as firms prepare for Phase 6. The compliance process will likely require a checklist – to assign roles and responsibilities internally, implement the most suitable IM calculation model, establish counterparty and custodial relationships, and create alerts to monitor IM threshold levels.
As the IM rules will require the setting up of segregated accounts with third-party or independent custodians, the complexity of managing this administrative activity and collateral movements may push firms to either outsource this responsibility or automate. Depending on which structure they choose – third-party custodian or tri-party custodian – the onerous task of attaching the correct collateral standing settlement instructions to a margin call may fall on firms if the former is chosen.
Securing margin settlement
Given that more than a third of firms (39%) interivewed shared that they are still relying on manual methods to send collateral instructions – including e-mail, fax and portal provided by custodians – an automated and integrated plaform is needed to streamline the various steps in the collateral and margining process to facilitate margin settlement. Process automation should start from the point that the margin call has been pledged or agreed to the exchange of IM and progress through to the settlement of collateral with real-time status updates.
As some of the firms in scope for Phase 6 are new to margin exchange or have limited exposure to derivatives, they are sometimes less sophisticated in set up and slower to automate their operational processes. This operational challenge will become critical when Phase 6 begins and when exchanging cross-border collateral across time zones.
Moving full steam ahead
Firms must jump-start preparations to meet UMR Phase 6 obligations now. This includes a thorough assessment of their collateral and margin call process, as well as considerations around further automation. Firms will likely choose to outsource the management of collateral and margin calls, with others adopting automated solutions to streamline the highly laborious collateral management process, including margin agreement and collateral exchange.
As the September 1 2022 deadline will arrive in the blink of an eye, firms should also intensify operational readiness, working on legal agreements to open collateral accounts at custodian banks and establishing the process for instructing and monitoring collateral movements. While there are some firms that may opt to remain below the US$50 million IM exchange threshold, these firms should consider unforeseen changes in market conditions that may suddenly increase their exposure – requiring them to exchange IM. The key is to be prepared, both for UMR Phase 6 and for the next high-volatility event which is sure to come.
Bob Stewart is the executive director of institutional trade processing at DTCC.