Meeting the initial margin challenge - part 1

And why you should have started the process now if you need to comply in 2020

4 December 2018

With the dust still settling on the latest crop of firms to comply with BCBS-IOSCO regulatory initial margin (IM) requirements, the spotlight turns on the much larger number of firms expected to fall in-scope in the remaining two phases: between 30 and 50 firms in Phase 4 (2019) and 750 to 1000 firms in Phase 5 (2020).

Aware of the scale of the challenge facing these firms, and with valuable experience gained from helping clients to achieve compliance in the earlier phases, we recently held a webinar on the topic. The aim? To highlight the legal and operational implications of the new IM regulation, identify potential trouble spots in the compliance journey - and indicate where help can be found to overcome these.

To this end, Sophie Marnhier-Foy, Calypso’s Global Principal Product Manager for Margin and Clearing Risk and Strath Lanyon, Director of Professional Services for APAC, were joined by Isda’s Rahul Advani, Director of Public Policy, and Nnamdi Okaeme, Director of Risk and Capital. 

One message came through clearly from all speakers: the importance of allowing a two-year preparation timeline leading up to the IM compliance date.

This means that the 750-1000 firms needing to comply in September 2020 should be starting the process now, while the 30-50 subject to the 2019 deadline should have preparations well in hand.

Unfortunately, the Isda Future of Derivatives survey carried out in early 2018 suggests that this is not the case. Just under 5% of respondents describe their readiness for the next phases of IM roll-out as “well progressed”, with almost half admitting to being “behind schedule” and more than eight per cent characterising their preparations as “little to none”.

It seems that a lot of work remains to be done. But there is help out there - plus experience gained in the early IM phases.

And firms expecting to be in-scope for compliance in September 2019 and 2020 will find Isda’s eight-step approach to Getting Ready for IM Regulatory Requirements a good starting point.

An 8-stage journey

Isda’s Rahul Advani, ran through these steps in the webinar, highlighting those that have proved particularly time-consuming and so should be started at an early stage. These potential ‘road blocks’ include:

Identify in-scope entities early
This is essential for planning purposes.

Whether and when a firm comes into scope for IM regulation depends on the overall size of its derivatives portfolio and is determined by the aggregate average notional amount (AANA) of its OTC derivatives.

For Phase 4 (September 2019), the AANA threshold is €750bn; for Phase 5 (September 2020), it falls to €8bn (or similar amounts in other currencies, depending on local regulations).

The final determination can only be made after the ‘AANA observation window’ has occurred - typically between March and May for a September compliance date.

But, firms will have to produce estimates of AANA long before this observation window if they are to have sufficient time to prepare for IM compliance.

Make early disclosure to counterparties

Isda recommends that firms start to determine the number of counterparty relationships that will be affected some 12-18 months before the IM go-live date. For example, to achieve compliance in September 2020, firms should start this task in March 2019.

More time should be allowed for Phases 4 and 5, however, when a greater number of counterparties fall inscope at the same time.

Isda has tried to make this process easier. To avoid firms having to make individual calls to counterparties (a time-consuming task), it has produced a standard self-disclosure letter (SDL), available electronically, to assist with the exchange of information needed.

Establish custodial relationships
Firms need to establish relationships with the relevant custodians, and provide information on all in-scope counterparty relationships. Be warned, our experience suggests this process can take months as KYC checks may need to be performed. Once again, an early start is advised.

Prepare for compliance
This includes preparing the regulatory IM calculator (Isda SIMM and/or regulatory grid) and ensuring the appropriate operational capacity is in place - including any additional IT or system development required.

A decent lead-time should be allowed for this process.

Negotiate/execute documentation
This includes bilateral IM CSA or collateral transfer agreements/security agreements for each counterparty pair and trilateral account control agreements or similar documentation for each counterparty/custodian trio.

From our previous experience, the size and complexity of working through those new agreements with counterparties should not be underestimated.

The IM clock is ticking

But referring back to the Isda survey, even if you are among the 70% of firms whose state of preparedness is not where it should be at this point, there is help out there – and ways you can ease the load.

The second article in this series considers the advantages of using a ‘market standard’ IM calculator in the form of ISDA SIMM.
Access the full on-demand webinar here.

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