While the recent delay in the BCBS/IOSCO deadline for the introduction of new collateral management requirements for non-cleared derivatives may have been a welcome move for most of the derivatives industry, Omgeo’s Moris Danon urges firms to take advantage of the extra time allotted to ensure compliance is successful and explore some of the challenges firms face as they keep pace with the market changes.
Julia: Was the delay in the deadline generally welcomed by the firms you have spoken to?
Moris: Absolutely yes. Many firms were not in a position to meet the BCBS/IOSCO requirements by the original target date of December 5, 2015 so the extra time is welcome. The impact of some of the proposed changes is quite complex, and the pressure to “do something” to meet the dates appeared to conflict with the ability to adopt operational and technical approaches better suited to represent long term solutions supporting the global collateral requirements.
Julia: In terms of preparations, how far progressed were, or are most firms in meeting the new BCBS/IOSCO requirements? Were they at risk for missing the deadline to begin with?
Moris: There was a wide range in the level of preparedness and a big divide between the sell and buy side. Many buy side firms were barely aware of the requirements, but upon reviewing their notional and derivative volumes, they would have been subject to the variation margin requirements on December 1, 2015, and initial margin requirements within the initial phases. The sell side, particularly the larger firms who would have been subject to the regulations sooner, began analyzing the requirements in great detail shortly after the September 2013 publication of the BCBS/IOSCO framework for margining non-cleared derivatives. They evaluated their current collateral management solutions and applications as well as looked at third party vendors and outsourcers to assess the gaps between the requirements and the applications’ current capabilities. Some major firms, given the deadlines and the magnitude of the work, decided to join their forces and resources and work towards a shared solution in the shape of a utility.
Julia: Do you think the delay will change the options such as shared solutions that firms will go with?
Moris: The delay gives firms some breathing space in which to better evaluate options. There are a number of factors which firms need to weigh, including a utility solution, internal development, vendor solutions or out-sources services. There is no one-size-fits-all solution, and the ability to determine the best overall solution is enhanced with this additional time. There are a number of requirements that are still to be finalized. Whatever solution(s) ultimately are chosen will need the time to effectively solve for these finalized requirements.
Julia: What are some of the challenges – operational, technological or / and organizational that firms face in preparing for these new requirements? How will the extended deadline help them address these challenges more efficiently?
Moris: Although firms will now have more time, the extent of their operational, technological and organizational challenges will depend on the flexibility of their technology, and their current OTC bilateral margining capabilities. I think buy-side firms who were not posting any margin (because they were not required to post margin for their bilateral transactions) will find it more difficult to meet the requirements than the sell-side firms. The rules will require them to establish new departments, organizations and operations in an area they may not be familiar with nor have internal expertise in.
It will also be more challenging for those platforms that did margining for only one type of business or didn’t handle the entire workflow or scope required. They may need to replace existing technology unable to add new functionality to meet the new requirements. Firms will also need new or updated collateral documentation and some will require new custodial agreements for segregating initial margin, which is a requirement in the US for uncleared derivatives.
Julia: Can you break out some of the specific challenges firms will face?
Moris: Challenges include:
Currency silos involves monitoring the derivatives obligation currencies, the collateral asset currencies, and associating them in currency buckets in order to determine if additional initial margin FX haircut will apply or not. This will require multiple currency margin calls to be calculated and maintained for a single portfolio, and applies to both Europe and the US. This differs from the typical current practice of having an agreement base currency where all the exposure transactions and collateral assets are converted to the base currency and one margin call is calculated in a single currency.
Cross-border differences. Unless the discrepancies between Europe, the US and Asia are harmonized, firms may need to maintain multiple sets of rules within a single agreement and ensure that they can assign all these different rules to the relevant counterparty of the agreement.
Material Swaps Exposure and the threshold calculations are now going to be at the group level for all affiliates in Europe and the US. The rules concerning affiliates and determining the threshold for the entire group is difficult both operationally and from a technology perspective. The method for allocating the group level threshold to the agreements of the individual affiliates is still to be determined.
Legacy trades. These are contracts entered before the new regulations take effect. Although the rules have not been finalized, in Europe, legacy trades will not be subject to the new regulations but this will imply managing two sets of transactions with completely different rules within the same agreement, which presents operational and technological challenges. On the other hand, US regulators did allow (if there’s a Master Netting Agreement) combining legacy trades with the new contracts entered after the regulations are implemented. While easier operationally, it has a drawback in that the older contracts will now be subject to the higher margins of the new, stricter regulations. An alternative to the US regulation, having a separate master netting agreement for swaps entered into after the proposed rule’s compliance date in order to exclude swaps entered into with a counterparty prior to the compliance date, has the drawback of losing the netting benefits.
Automation. The significantly increased number of calls under the new regulations will require additional straight through processing and automation, and potentially changing the existing margin operations processes within an institution.
Julia: In terms of automation, is that something that is needed more on the buy side who tend to have more manual based processes, or will it be something that both buy and sell-side institutions will ideally strive towards?
Moris: I would think that both buy side and sell side from their own perspectives would require additional automation. The sell side today may be better equipped in terms of workflow and STP than the buy side, but their margin volumes will increase significantly and they will also need to increase their automation.
Julia: What capabilities are firms looking for beyond just BCBS/IOSCO requirements compliance tick boxes?
Moris: Companies looking for a technology solution need to evaluate more than just the software. The software has to be functionally complete, flexible and scalable to support the firm as the business grows and develops. Technology providers need to be evaluated for their fit with the organization. Is the vendor a good long-term partner? What is the vendor’s support structure? How stable is the vendor? Does the vendor have a track record of success? These are just a few of the questions firms need to answer before selecting a vendor.
Julia: Why is it important that firms keep momentum going when working towards compliance with these requirements?
Moris: The delay that ISDA and SIFMA requested was two years after the regulations were finalised and not two years from December 2015. So, if that two-year delay had been granted, maybe that would have given reason for some firms to lose momentum, re-evaluate, and devote resources to more urgent projects. In my opinion the nine-month delay from the December 2015 deadline simply makes it more feasible to meet the requirements when they go into effect. However, given the magnitude of technology and operational changes to be implemented, the nine month extension is not really long enough to warrant pausing and losing momentum on their efforts. It will probably allow some firms to have more achievable project timelines in order to complete their work.
Julia: As a provider in this space, how has the delay impacted in terms of supporting your clients?
Moris: The rules have had a significant impact on Omgeo ProtoColl since 2013 when the first framework was published by BCBS/IOSCO, and then when ESMA, the US Prudential Regulators and the Commodity Futures Trading Commission (CFTC) published their own versions of the regulations in 2014. It was vital that we keep up with the regulatory changes and analyze the impact of these new rules because BCBS/IOSCO was in the minds of existing clients and prospects looking for a collateral management solution.
More specifically, in order to be able to support our clients’ needs, we had to look at every single regulatory requirement and relate them to the current system functionality to see what was already supported. From there we analyzed the areas where enhancement or development was needed to meet the requirements. Like every software vendor, ProtoColl had its own development plans and roadmap, which includes the priorities supporting our clients in meeting the BCBS/IOSCO requirements. Continuing uncertainty around the final rules remains a major obstacle to completing the requirements on time for firms to test and implement them.
