Counterparties that will now come under the new uncleared margin rules threshold have misjudged the level of work and technology build necessary to be able to fulfil requirements set out by the International Swaps and Derivatives Association (Isda)’s SIMM methodology, market participants agree.
“One thing we are seeing in terms of what is available - whether that’s in documentation, vendor solutions, or technology accessible to the firm - one thing to bear in mind is because SIMM is such a quantitative model compared to other margin models, I think a lot of firms are underestimating the amount of work that is going to be required to implement this and streamline the process,” says Veeral Manek, head of product specialist at OpenGamma.
“What we saw a couple of months ago was that a lot of even the sophisticated firms attempted to do it themselves internally, but then when it actually got down to it they realized the methodology is very different and more complicated than their existing view of risk, and it is going to require so much extra work.
“That’s why there are so many vendors in this space who are offering a solution to this. That is where the trend is going to go, i.e. a lot of the firms that thought that they could do it themselves will end up outsourcing it,” he says.
Under the Basel Committee on Banking Supervision (BCSC) and the International Organization of Securities Commission (Iosco) framework for margin requirements for non-centrally cleared derivatives firms must calculate their aggregate average notional amount (AANA).
In September firms will be required to exchange initial margin if they hold non-cleared OTCs with an aggregate notional value exceeding the €750bn threshold. That threshold is scheduled to drop to €8bn in September 2020.
The Standard Initial Margin Model (SIMM) 2.1 is a common methodology for the calculation of initial margin for uncleared swaps.
On May 17, Isda urged European policy makers, and national regulators to calibrate the European Market Infrastructure Regulation (Emir) implementing rules on: “the back-testing and internal governance requirements associated with the use of globally approved IM models, including the Isda SIMMTM (SIMM).”
For Eduardo Pereira, Bloomberg’s SIMM product owner, challenges lie in having a quant team that understands how the SIMM model works and can implement it from a coding point of view.
“The challenge that I see for a smaller firm is having access to a small quant team that can implement the SIMM model in software code, or even access to a front or back office solution that allows you to generate sensitivities for the OTC derivative portfolio you are actually trading with your counterparty,” says Pereira.
Issues will arise as the counterparties that come under the threshold come to terms with what is required, according to Manek.
“There is a lot of description of how you need to be able to calculate your SIMM requirements both from your perspective, your counterparties perspective, you need to run it through a reconciliation platform, you need to iron out IM disputes throughout the day, and suddenly you have these service-level agreements which are going to be in place that will need to be adhered to,” he says.
“I can imagine that there may be further issues down the line as these 9,000 counterparties are suddenly adding on these new operational constraints into their workflow, and I think that might trigger more discussion with the regulators.”
However, Pereira says buyside firms are struggling to get their heads around the backtesting requirements.
“In Europe what we see is a lot of the buy-sides struggling with the notion of having to backtest the SIMM levels, because it is really a significant cost and they need market risk technology, i.e. they need a market risk engine to generate the P&L vectors associated to the Isda backtests. They see backtesting as a real challenge. They don’t actually want to go through the SIMM backtesting process that the local jurisdiction regulators prescribed.”
“There is also a cost for maintaining the SIMM model on an annual basis, as Isda revises its methodology and model composition annually.
While the SIMM methodology is more complex than previous margin methodologies, the reduced amount of required initial margin will push many of those buy-side firms towards implementing the technology to meet the calculation requirements, according to Manek.
“In a cleared environment the methodologies are driven by CCPs, and generally speaking they are reasonably transparent in terms of how the margin is calculated. However, for SIMM the methodology is slightly more complicated because the inputs to the model are sensitivities as opposed to positions which requires an additional layer of analytics and risk calculations that has to be done by the firm, or a vendor employed by the firm,” he says.
“SIMM is more complicated to calculate, however, it is less punitive in terms of the actual margin that you need to post which is why there is an incentive for firms to go through the effort of implementing SIMM.”