At a recent webinar hosted by Refinitiv, Mike Fitzsimmons, a senior executive from AustralianSuper, discussed preparations for Phase 6 of the Initial Margin regulations, providing expert insights that should serve as a useful guide for buy-side firms.
- The phased roll-out of new regulations around uncleared derivatives, intended to reduce counterparty risk and improve collateral management, were delayed a year due to COVID-19. Now back on course, final stages 5 and 6 will go live in September 2021 and 2022, respectively.
- A Refinitiv webinar discussed how best to apply the resourcing lessons learned from Phase 5 to the final stage, and the different Initial Margin calculation options available.
- The panel also discussed challenges related to documentation, and onboarding counterparties, service providers and custodians.
For more data-driven insights in your Inbox, subscribe to the Refinitiv Perspectives weekly newsletter.
Initial Margin rules, which aim to streamline collateral management and minimise counterparty risk, have been progressively coming into play since September 2016.
A firm’s need to comply with a particular phase of the rules is based on its aggregate average notional amount (AANA) of non-centrally cleared derivatives, and when that falls into a pre-agreed regulatory threshold.
The range of instruments in scope is broadly similar across Asia Pacific, Europe and the U.S.; although within equity derivatives there is some divergence in APAC, and even further variations between Australia, Singapore, Hong Kong and Japan.
Phase 5 is expected to go live in September 2021 with an increased AANA threshold of €50 billion while Phase 6 will go live in September 2022 with the original Phase 5 AANA threshold of €8 billion.
Who will be impacted by the Initial Margin regulations?
With studies by the International Swaps and Derivatives Association (ISDA) suggesting that around 1,000 firms globally will be impacted, the insights drawn from this webinar should prove timely.
A point that was underlined by the findings of an initial spot poll of the audience, which showed that most of the respondents felt their firms had much to do in order to be ready for Phase 6.
Resourcing lessons learned so far
The webinar began with a discussion on preparations for Phase 6 and a look at the most recent lessons learned from rolling out Phase 5.
“Once the fund confirmed it was captured by the AANA regulation, it was a case of understanding the different component parts of it,” said Mike Fitzsimmons, Manager of Securities Lending, AustralianSuper. As Australia’s largest superannuation fund, its threshold of notional non-cleared derivatives meant that it was required to meet the regulations for Phase 5.
“We had immediate issues to consider,” Fitzsimmons added. These included how the margining calculation would be performed, and if parts of the task could be delegated to an accredited calculation vendor, he explained.
Other questions that needed answering included the exact way in which the pledging of non-cash collateral to bankruptcy remote accounts would work, the legal and compliance documentary requirements, and the process of onboarding with multiple custodians, as well as the best ways to test and optimise collateral management.
Recognising that the endeavour would create a significant demand for manpower and involve multiple departments across the organisation, AustralianSuper hired dedicated project management resources to work alongside its subject matter experts in the investment, compliance, operations, legal and risk teams, according to Fitzsimmons.
“We prioritised what’s become a demanding 18-month piece of work from the outset.”
Fitzsimmons explained that in this way, AustralianSuper used a blend of internal and external resources to implement the rules framework for the Initial Margin calculation and collateral management; delegating activities where it was appropriate, or where it wasn’t beneficial to build expertise that a service provider could readily supply.
The popularity of this approach among companies preparing for the next phase was emphasised by another spot poll of the webinar audience, which showed a clear majority in favour of using a combination of internal and external resources for those functions
Which Initial Margin model to choose?
Further, the panellists discussed the relative merits of the two Initial Margin calculation options available: the table (or schedule)-based approach and the more popular internal Standard Initial Margin Model (SIMM) developed by ISDA.
“The SIMM calculation from ISDA is clearly proving to be the preferred approach for firms so far,” said Jordis Sinnott, Senior Customer Success Manager, Refinitiv.
“Yes, and our preference was also the SIMM model,” concurred Fitzsimmons. “It seems to be the industry standard so far, and is more efficient in the way it accounts for offsetting risks across a portfolio. Asymmetric calculation approaches may possibly be agreed between margining parties, but adds complexity and has not been observed in earlier phases.”
The panellists stressed that a consistent IM calculation approach would provide extra benefits for those operating in APAC, a region characterised by wide regulatory fragmentation and where some countries lack rules around uncleared derivatives margins.
An audience poll also demonstrated a preference for the SIMM calculation model.
At the same time, the panellists noted that while it was the preferred approach so far, the SIMM calculation model brought with it some demanding data requirements.
“With inputs including market data, trade data and SIMM calibrations, we used millions of data points from our data provider; across different time periods, asset classes and tenors – all piped into a calculation vendor”, said Fitzsimmons. “Some vendors will do the end-to-end process for you, but at a cost. We leveraged existing vendor relationships where possible to mitigate those costs.”
A final poll of the webinar audience demonstrated significant uncertainty around how to meet the data requirements for calculating Initial Margin effectively.
The documentation challenge
While acknowledging that fulfilling the data requirements for the Initial Margin calculation can be demanding, the panellists discussed an equal, if not greater challenge, around the volume of onboarding paperwork involved.
“Your counterparties will typically be managing bilateral documentation via central teams covering many counterparties themselves; prioritising their workload based on likely margin threshold breaches”, noted Fitzsimmons.
“The challenge is one of gaining time and attention. You have a complex documentary landscape between your legal, counterparty legal and internal teams. And bear in mind that different counterparties may be subject to different regulations, particularly within the regulatory diversity of the APAC region.”
Onboarding with external service providers, and crucially with your custodian, can also be time consuming, with service level and commercial agreements in play, Fitzsimmons went on to explain to the audience.
He rounded off by pointing out the need to consider the onboarding required with a counterparty’s custodian as well – with KYC implications if that relationship is a new one.
Advice for entrants to Phase 6: begin early
In conclusion, Fitzsimmons summarised his recommendations for buy-side firms preparing for Phase 6:
- Be mindful of APAC regulatory variations and the complexity this adds.
- On the monitoring side, build or obtain a tool to measure your AANA as soon as possible. Identify counterparties where a breach is most likely and prioritise those for onboarding. Understand your runway to breaching a margin threshold and demonstrate controls around this.
- On the implementation side, robust counterparty engagement is crucial for the agreement of legal documentation, and calculation testing of the SIMM model. Onboarding a calculation vendor takes time, with mapping, data inputs and validation, followed by output testing. For your custodian, testing end-to-end transport of collateral is critical, alongside the setting up of eligible collateral schedules.
Finally, he reminded the audience that seeking regulatory approval is a substantial task in itself. “So, even with a September 2022 due date, you really can’t begin Phase 6 preparations early enough.”