Uncleared margin rules - 10 actions Phase 5 and 6 counterparties must take now - 10 actions Phase 5 and 6 counterparties ...
←
→
Page content transcription
If your browser does not render page correctly, please read the page content below
Uncleared margin rules — 10 actions Phase 5 and 6 counterparties must take now
Introduction
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
“
Firms across Phases 5 and 6 need to
act now and accelerate their efforts
requirements. With the Basel Committee of Banking to make certain capabilities are in
Supervision (BCBS) and International Organization of place on time. Failing to act now
Securities Commissions (IOSCO) announcement on April 3,
2020, revising their final policy framework to include a further will put the firm’s ability to transact
one-year delay for Phase 5 and Phase 6 firms, there is an in OTC bilateral derivatives at
opportunity for firms to step back and make certain that they
are approaching this opportunity strategically. significant risk. This is not the time
While the BCBS-IOSCO revision needs to be adopted by local to slow down, but an opportunity
jurisdictional regulators, this revision is a welcome relief for the to reassess and make sure you meet
industry, currently dealing with significant spikes in margin call
volumes and valuation disputes driven by COVID-19 market
your long-term needs.
volatility. We also observe that many organizations were
– Mark Nichols, EY Collateral Lead
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 extended the IM compliance timeline for covered entities with
collateral management operations requirements and invest an AANA greater than $8 billion but less than $50 billion to
in the right solutions and partners to strategically meet their September 1, 2022 (Phase 6). Covered entities with an AANA
infrastructure needs. greater than $50 billion will be subject to the IM requirements
Firms across Phases 5 and 6 for initial margin (IM) need to on September 1, 2021 (Phase 5).
act now and accelerate their efforts to see that all capabilities Phases 5 and 6 are anticipated to bring over 1,000 entities
are in place on time. Not acting now will put the firm’s ability across banks, asset managers, hedge funds, pension funds,
to transact in over-the counter (OTC) bilateral derivatives insurance and corporate firms, swap dealers and governmental
at significant risk. This is not a time to slow down, but an entities in scope of the UMR framework. This large increase
opportunity to reassess and make certain you meet your in the number of counterparties subject to the regulations
long-term needs and accelerate the delivery of a scalable and presents various challenges for the industry that we will
regulatory compliant platform. discuss in this paper.
The UMR framework was developed to reduce systemic risk in It is imperative that all Phase 5 and 6 firms have programs in
the OTC derivatives market by requiring the exchange of both place to accelerate readiness and work with their dealers and
variation margin (VM) and IM. Compliance timelines are based vendors on implementing appropriate strategic solutions. This
on total aggregate average notional amounts (AANA). With will make certain that the impact of the inevitable bottleneck
COVID-19 impacting global markets with increased volatility of onboarding is minimized and an appropriate long-term
and uncertainly, the revised BCBS-IOSCO policy framework capability delivered.
1 | Uncleared margin rules — 10 actions Phase 5 and 6 counterparties must take now
Regulatory and advocacy updates
To address growing concerns about market disruption due to the volume and relative size of new in-scope counterparties, various
regulatory authorities have published proposed rules. In response, industry organizations have released industry advocacy and public
comments with regard to compliance timelines, as highlighted below.
The release of these policy frameworks and advocacy letters for IM requirements provides sufficient clarity on open questions to enable
firms that are subject to the rules to move forward with their programs and make the required decisions to enable operational and
technology readiness for UMR compliance.
1
With COVID-19 impacting the global financial industry in early to mid-2020, the markets experienced extreme
volatility leading to significant margin call and dispute volumes impacting collateral management operations
teams. The International Swaps and Derivatives Association (ISDA) sent a letter to BCBS-IOSCO on behalf of
21 industry associations requesting a suspension of the current timeline for IM phase-in due to required work-
from-home mandates, constraints from firms’ custodians, the lack of enforceability of electronic execution of
agreements, and the increased need to closely monitor market and credit risk. The request was to suspend
the current Phase 5 and 6 compliance timelines and reassess once markets are back to “normal” conditions.
On April 3, 2020, the BCBS extended the compliance timelines by a year for both Phase 5 (now
September 2021) and Phase 6 (now September 2022). This one-year extension is now pending
adoption from local regulators into their respective regulatory or legislative frameworks.
2
In October and November 2019, the Commodity Futures Trading Commission (CFTC) and the US Prudential
Regulators (US PR) published proposed rules on margin and capital requirements for covered swap entities in
accordance with the BCBS/IOSCO framework. The proposed rule also clarified that trading documentation must
be completed with a counterparty when a covered swap entity is required to post or collect IM and also included
technical changes to address amendments to legacy swaps subject to qualified financial contract rules.
In March 2020, the CFTC released an updated rule adopting the BCBS revised timeline at that time, extending the
IM compliance deadline one year for market participants with an AANA less than $50 billion.
With the one-year extension granted by BSCB and ISCO in April 2020 to extend the Phase 5 and 6 compliance
timeline because of impacts from COVID-19, the industry is pending feedback from the CFTC and US PR on
whether they accept and agree to these amended timelines.
3
The European Supervisory Authorities (ESA) proposed amendments confirmed no documentation requirements
for entities below the $50 million threshold and confirmed AANA threshold amendments for Phase 5 and 6
counterparties. The ESA also proposed that VM exchange for FX swaps and FX forwards with physical settlement
is optional, and that margining requirement for OTC equity options on single names or indices be postponed until
January 4, 2021. The ESA has yet to respond to the additional year of compliance relief.
2 | Uncleared margin rules — 10 actions Phase 5 and 6 counterparties must take now
10 actions Phase 5 and 6
counterparties must take now
From our work supporting over half of the industry that is
operating under the UMR framework today, we have identified
10 actions to take now
10 actions that firms subject to the regulations need to be
progressing to make certain they are ready for compliance. As 1. Establish UMR program and
this is a cross-functional regulatory framework, preparation governance framework
starts with establishing an enterprise governance structure and
conducting an impact assessment across the organization. As part 2. Perform AANA calculation and
of these programs, detailed plans and cross-functional roles and scoping assessment
responsibilities must be defined to support regulatory compliance.
Highlighted below are the top 10 activities firms should focus on to 3. Determine appropriate operating
initiate and prepare for UMR compliance:
model from a people, process and
technology perspective
1. Establish UMR program and governance framework
4. Negotiate trading documentation
• Formulate a cross-functional UMR compliance plan for
implementation
with defined in-scope population
• Define executive in charge and program ownership across 5. Determine and calculate IM
key stakeholders responsible for key functional areas (legal,
calculation methodology
operations, risk, etc.)
• Establish timelines for key steps and requirements, 6. Implement changes to operational
including end-to-end industry testing
infrastructure
2. Perform AANA calculation and scoping assessment
7. Establish custody model and
• Perform AANA calculation and, if applicable, communicate
results specifically focusing on funds close to IM thresholds structure
• Re-perform AANA, on an ongoing basis, as needed to 8. Obtain model approval and testing
confirm the appropriate compliance timeline
(if applicable)
• Understand entity and fund structure, parent ownership
of funds, and type of accounts to determine scope and 9. Assess opportunities for collateral
applicability
optimization
• Self-disclose to relevant counterparties and engage early
with clients to accelerate implementation and onboarding 10. Plan for 2021 and beyond
3 | Uncleared margin rules — 10 actions Phase 5 and 6 counterparties must take now
10 actions Phase 5 and 6 counterparties must take now
3. Determine appropriate operating model from a people, Preparation starts with
process and technology perspective
establishing an enterprise
• Determine whether to build components in house or
leverage external vendors, in consideration of the following:
governance structure and
• Current state infrastructure capabilities and integration
conducting an impact assessment
of systems across the organization. As part
• Maturity of current workflow processes (i.e., manual of this program, detailed plans
vs. automated)
and cross-functional roles and
• Data availability and quality
responsibilities must be defined
• Size of derivatives portfolios across entities and
expected workflow impacts to support regulatory compliance
• Evaluate third-party vendors and determine suitable and strategic implementation.
option(s) given firm’s business strategy, infrastructure and
portfolio.
• Asset servicers and outsource providers: Collateral
management outsource providers perform valuation 4. Negotiate trading documentation with defined
services, IM threshold determinations and IM in-scope population
calculations. In some cases, providers can also help • Establish a negotiation road map early, including an
firms identify in-scope funds to support the AANA evaluation of your current state, such as the location of
calculation. Additionally, firms with manually intensive documentation, quality of contract metadata in the system
processes may consider outsourcing their collateral of record, and the capacity of the legal negotiation team.
operational processes.
• Prioritize counterparties for negotiation of IM
• Vendor software providers: Firms can also leverage documentation and account setup, based on the
vendor software and technology platforms as either importance of each account and trading relationship.
added on to existing infrastructure or as net-new to • Determine the custodians you will leverage that best
enhance current collateral management capabilities. suit your business, the custodians you anticipate your
Vendor solutions can be used specifically for IM counterparties to use and the timetable each custodian will
calculations or can be implemented more broadly to require to set up independent collateral accounts.
support collateral operations workflow.
• 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.
4 | Uncleared margin rules — 10 actions Phase 5 and 6 counterparties must take now
10 actions Phase 5 and 6
counterparties must take now
5. Determine IM calculation methodology Ultimate
asset
• Determine IM calculation methodology (e.g., risk-based owner
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). Investment Investment Investment
manager 1 manager 2 manager 3
• 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 Dealer A Dealer B Dealer C
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).
1 Does ultimate asset owner (UAO) in aggregate for managed
• Determine how to allocate the group-level $50m threshold funds relationship exceed the defined AANA level for gross
across funds and entities that transact with a common derivative notional?
counterparty.
2 Where yes, UAO needs to inform investment manager of the
6. Implement changes to operational infrastructure allocated split of the IM threshold per dealer:
• Assess scalability of existing infrastructure and maturity
• Investment manager and UAO need to agree on a
of current processes to support increased complexity and
rebalancing schedule in the event that they need to
volume.
redistribute the allocation
• Implement collateral operational processes to support daily
exchange of IM, risk and dispute management, connectivity • Initial splits could be even across relationships or based
to custodians, and internal and external data feeds. on a risk-adjusted allocation
• Assess current operating model and determine 3 Investment manager must then communicate the
opportunities for enhancements and potential vendor IM threshold allocation to the dealer for relationship
support (refer to item 10 for further detail). documentation (investment manager to dealer) and identify
selected segregation agent.
• Establish IM reporting requirements for regulatory and
internal downstream (credit, risk, compliance and finance)
purposes.
5 | Uncleared margin rules — 10 actions Phase 5 and 6 counterparties must take now
10 actions Phase 5 and 6 counterparties must take now
7. Establish custody and segregation model and structure 10. Plan for post-compliance and beyond
• Determine custody and segregation model to adopt • Firms need to evaluate their initial program and
between triparty or third party. business decisions, including scalability of their internal
• Initiate negotiation of Account Control Agreements (ACA) infrastructure for upcoming phases, geographical coverage
and other required custodian documentation. of custodians, custody model, IM calculation method and
in-scope entities.
• Build connectivity with current custodians as well as
dealers’ custodians with appropriate feeds for daily • Firms need to embed ongoing monitoring processes to
movement of IM collateral required value (RQV). check for compliance beyond the current compliance
timelines (e.g., ongoing AANA monitoring, threshold
• Engage in conversations with custodians to determine monitoring, building feeds to new product approval
suitability and confirm capacity, given the expected number processes).
of new in-scope entities, business strategy and required
geographical support.
Regardless of the changes to the implementation timelines,
8. Obtain model approval/testing (if applicable)
derivatives-trading entities will need to take immediate action
• For regulated entities, implementation of required to implement solutions that address their compliance needs.
regulatory approval from the firm’s prudential regulator Compliance with the UMR framework requires cross-functional
(depending on the regulatory jurisdiction). coordination across your firm (particularly across operations and
• Provide relevant documentation to regulators for review in technology, risk and the front office), significant outreach with
advance of and during the on-site model exam. counterparties, interaction with third parties and regulators (as
• Determine the appropriate data sources for risk applicable), as well as significant technological enhancements to
sensitivities, risk bucket mapping and P/L generation for support the IM calculation, ongoing monitoring and daily exchange
backtesting. of collateral.
9. Assess opportunities for collateral optimization Firms need to work now to achieve the timely implementation
of UMR compliance and to efficiently capitalize on collateral
• Develop optimization strategy given range of eligible
optimization opportunities. Many firms across both remaining
collateral for regulatory initial opportunity.
compliance phases are significantly behind and need to quickly
• Confirm counterparty appetite and custodian capability to accelerate and focus on key activities. The time, effort and
support collateral optimization approach. coordination have been grossly underestimated by many Phase 5
• Leverage analytic tools for what-if scenarios to help and 6 firms. The time to act is now.
determine optimal trading decisioning.
6 | Uncleared margin rules — 10 actions Phase 5 and 6 counterparties must take now 6
Are you on track to UMR
compliance?
The below timeline is based on leading practices and includes illustrative activities and milestones required by all in-scope firms. Many
of these requirements are complex and require collaboration across organizations. Firms should start to mobilize to stand up their UMR
programs now to allow for additional time to execute the necessary actions and activities that are required to meet compliance.
Months Indicative UMR compliance timeline
T-18 • Perform preliminary AANA calculation across entities
• Establish internal governance framework and cross-functional program
• Understand entity/fund structure, parent ownership of funds, and account types to confirm scope and applicability
• Review vendors and determine in-house or external vendor for IM calculation (i.e., SIMM vs. grid)
T-15 • Finalize AANA calculation across entities
• Complete self-disclosure documentation
• Determine IM calculation methodology (e.g., SIMM, grid)
• Allocate IM threshold across entities
• Establish appropriate operating model from a people, process and technology perspective
T-12 • Determine custodian and segregation model (i.e., third party vs. triparty)
• Perform SIMM testing and obtain model approval (if applicable)
T-9 • Begin to implement changes to operational infrastructure
• Develop optimization strategy
T-6 • Establish IM reporting requirements for regulatory and internal downstream purposes
• Develop operational and dispute procedures based on new functionality
• Perform SIMM testing and obtain model approval (if applicable)
T-3 • Execute agreements with custodians and onboard into margin system including updated eligibility restrictions
• Complete testing, systematic implementation, and connectivity to custodians and IM calculation vendors
Compliance • Perform and monitor ongoing entity AANA and threshold checks
date
7 | Uncleared margin rules — 10 actions Phase 5 and 6 counterparties must take now
How Ernst & Young LLP can help
The EY team has extensive knowledge and industry experience The EY UMR cross-disciplinary offering team includes advisors who
with supporting over 50% of Phase 1-4 firms with their uncleared have been dedicated to this topic since 2014, having worked with
margin programs. Our solutions support clients with accelerating the largest dealer organizations, industry bodies, key custodians,
IM compliance readiness and are tailored to each client’s portfolio, vendors, as well as smaller organizations subject to the framework.
business strategy and compliance needs, including but not limited We have authored a broad range of articles; presented at industry
to, the following: and webinars on the impact of the uncleared margin requirements
jointly with the ISDA, Securities Industry and Financial Markets
• Program management and mobilization
Association (SIFMA), Managed Funds Association (MFA) and
• Technology implementation International Securities Association for Institutional Trade
• Model development, testing and regulatory approval readiness Communication (ISITC); and supported industry trade associations.
For further detail, please reach out to our offering leads.
• Collateral assessment and implementation of enhanced margin
workflows
• Regulatory assessment and remediation support
The EY team has extensive
• Strategic collateral operating model initiatives
knowledge and industry
• Vendor assessments
experience with supporting over
• Contract negotiation services
50% of Phase 1-4 firms with their
• Controls, compliance and audit review
uncleared margin programs.
8 | Uncleared margin rules — 10 actions Phase 5 and 6 counterparties must take now
EY contacts
EY | Assurance | Tax | Transactions | Advisory
About EY
EY is a global leader in assurance, tax, transaction and advisory
services. The insights and quality services we deliver help build trust and
confidence in the capital markets and in economies the world over. We
Mark Nichols develop outstanding leaders who team to deliver on our promises to all
Senior Collateral Lead of our stakeholders. In so doing, we play a critical role in building a better
working world for our people, for our clients and for our communities.
Ernst & Young LLP
+1 212 773 2701 EY refers to the global organization, and may refer to one or more, of
the member firms of Ernst & Young Global Limited, each of which is
mark.nichols@ey.com
a separate legal entity. Ernst & Young Global Limited, a UK company
limited by guarantee, does not provide services to clients. Information
about how EY collects and uses personal data and a description of the
John Boyle rights individuals have under data protection legislation are available via
Senior Manager ey.com/privacy. For more information about our organization, please
Ernst & Young LLP visit ey.com.
+1 212 773 5412 Ernst & Young LLP is a client-serving member firm of Ernst & Young
john.boyle1@ey.com Global Limited operating in the US.
EY is a leader in serving the global financial services marketplace
Nearly 51,000 EY financial services professionals around the world
Anthony DiMatteo provide integrated assurance, tax, transaction and advisory services to
Senior Manager our asset management, banking, capital markets and insurance clients.
Ernst & Young LLP In the Americas, EY is the only public accounting organization with a
separate business unit dedicated to the financial services marketplace.
+1 646 543 1078 Created in 2000, the Americas Financial Services Office today includes
anthony.dimatteo@ey.com more than 11,000 professionals at member firms in over 90 locations
throughout the US, the Caribbean and Latin America.
Carlos Alvarez EY professionals in our financial services practices worldwide
align with key global industry groups, including EY’s Global Asset
Senior Manager Management Center, Global Banking & Capital Markets Center, Global
Ernst & Young LLP Insurance Center and Global Private Equity Center, which act as hubs
+1 212 773 6920 for sharing industry-focused knowledge on current and emerging
trends and regulations in order to help our clients address key issues.
carlos.alvarez@ey.com
Our practitioners span many disciplines and provide a well-rounded
understanding of business issues and challenges, as well as integrated
Erica Becker services to our clients.
Manager With a global presence and industry-focused advice, EY’s financial
services professionals provide high-quality assurance, tax, transaction
Ernst & Young LLP
and advisory services, including operations, process improvement, risk
+1 212 773 9443 and technology, to financial services companies worldwide.
erica.becker@ey.com
© 2020 Ernst & Young LLP.
All Rights Reserved.
Jimmy Ryan
Manager
SCORE no. 08924-201US
Ernst & Young LLP 2003-3461859 BDFSO
+1 212 773 3850 ED none
jimmy.ryan@ey.com
This material has been prepared for general informational purposes only and is not intended to
be relied upon as accounting, tax or other professional advice. Please refer to your advisors for
Christine Yuen specific advice.
Manager
Ernst & Young LLP
ey.com
+1 212 773 4529
christine.yuen@ey.comYou can also read
