Airtight CSAs, collaboration between desks, and STP are top priorities for financial firms as they prepare for bilateral margin rules to go live later this year. Olivier Grimonpont, Global Head Securities Financing and Collateral Management Products at Euroclear, explains.
BCBS-IOSCO margin requirements for non-centrally cleared derivatives are scheduled to come into force for top-tier broker dealers this September and many of these dealers – and their service providers – still have much to do ahead of that deadline.
Communication, CSAs and thinking beyond cash
First and foremost, banks need to ensure they have the right information flows in place between the owner of the asset—the department that is managing collateral for the firm as a whole—, the OTC derivatives team carrying out the collateral margining process, the risk management team and the legal/documentation department.
The different departments within the bank will need to establish effective communication channels with each other, which may be a new scenario for some firms. Traditionally, many top tier firms have been operating in a silo-based structure where OTC derivatives and collateral were managed independently from one another. In the new world however, OTC derivatives and collateral need to work closely together.
Firms also need to tackle legal and documentation requirements ahead of the upcoming deadline. Firstly, dealers need to have airtight credit support annexes (CSAs) in place with all their counterparties—a process, which is only just getting underway for many firms. Market participants also need to make sure they have the processes in place to support the upcoming management of margin calls, the reconciliation of exposures with all counterparties, and the mobilisation of the necessary assets from a collateral taker to a collateral giver, using pre-defined eligibility criteria. All these operational processes need to happen within a very strict legal framework so CSAs need to be negotiated carefully. Doing so takes time.
Cash has most commonly been used for variation margin (VM)—and may also be used for IM in the beginning. However, current market conditions are rendering cash collateral considerably less attractive and regulators are also pushing to reduce the amount of cash that is exchanged as IM. So, firms will need to adapt their operational processes to allow them to manage securities collateral as well.
STP is Essential for Reducing Error
To start with, firms need to ensure they have the right account structures in place, accurately documenting the allocation and transfer of collateral between different accounts. Proper reporting must then feed that data into their risk management and financial systems for, amongst others, risk-weighted asset (RWA) calculations. To maximise efficiency, reduce cost and ensure STP, firms are trying to leverage current infrastructure as much as possible by enhancing their processes and adding new functionalities into existing systems and flows.
In terms of infrastructure, there are a few layers to focus on throughout the collateral management lifecycle. For instance, dealers need a solution, such as the one provided by AcadiaSoft which enables them to not only calculate margin calls, but also more importantly, reconcile exposures and margin calls across counterparties and trades. Agreeing exactly what type of assets are to be received and given is a pre-requisite for the efficient and timely mobilisation of collateral. And this is where Euroclear adds tremendous value by bringing over three decades of collateral management experience into the world of OTC derivatives margining.
Firms can manage their margin exposures either directly via our flagship collateral management solution – the Collateral Highway – or through the DTCC-Euroclear Global Collateral Limited (DEGCL) joint venture, offering a truly global solution to a global issue. Irrespective of what clients choose, these solutions are fully integrated with our proven triparty platform that dealers are already familiar and comfortable with, having used it for the last 30 years to cover their financing needs. The solutions we offer allow for the mobilisation of assets from both sides of the Atlantic, segregation of collateral exchanged to ensure full protection, immediate availability in the event of bankruptcy by either party and complete compliance with regulatory requirements..
Sell-Side vs. Buy-Side Preparations
The September deadline applies to top-tier broker dealers, who represent the vast majority of OTC derivatives volumes being traded. However, longer term, the rules will be rolled out to the smaller broker dealers and the buy side. For now, industry participants and vendors are working hard to ensure their solutions are compliant; CSAs between dealers and counterparties are in place; operational processes are clearly defined; firms have determined which specific assets are eligible to be used as collateral; and custody services providers have been selected and approved.
There is a disconnect between how sell-side and buy-side firms are preparing for the new requirements. While both are making progress, a report Euroclear commissioned last year shows that the approaches often differ. On the sell side, front office desks have been heavily involved with preparations, as collateral management is a core part of the banking business. On the buy side, however, collateral management runs alongside trading. They have built or bought systems, but there is a need for greater front-office involvement in the whole process.
The DTCC/Euroclear joint venture, Global Collateral’s margin transaction utility (MTU), soon to be launched in the US will support these flows, especially for the buy side. By automating settlement and transfer instructions, the MTU reduces the risk of settlement and deadline errors, making the exchange of variation margin between the buy and sell side more efficient.
Implementation Delays Remain a Possibility
In Europe, the rules have yet to be finalised, and even once rules have been issued, they will still need to be translated into laws. This is a very challenging and tight schedule. Indeed, the European Banking Federation has asked for a further delay to the implementation of new IM rules for the biggest dealers—the requirements were originally scheduled to come into force in December 2015.
However, as US rules will come into effect in September regardless, a delay to the European implementation could unintentionally add complexity to an already complex process, with firms facing different requirements in different jurisdictions. Even if there is a delay in Europe, many of the firms will need to be ready for the US rules anyway, and a delay—while it might give dealers in Europe a little more breathing room—will not reduce the amount of work that needs to be done.
Irrespective of delays around the implementation of these rules, whether through Euroclear’s Collateral Highway or through the DEGCL, our resilient and cost-effective solutions are ready to support the market as it adapts to the new regulations that are re-shaping the world of uncleared OTC Derivatives.