Industry experts answer some of the audience questions on margin reform from a recent DerivSource webinar “Margin Reform: Regulatory Update & Operational Impact,” sponsored by Lombard Risk. Read on for answers to questions on initial margin (IM) and variation margin (VM) implementation deadlines, tools and solutions and more, or watch the on demand video of the webinar.
Q: Will VM be calculated and called for from 1 March 2017 even if documentation is only completed after this deadline?
Ted Leveroni, DTCC: The decision to calculate and collect VM is between the counterparties and in the absence of proper documentation would ultimately be left to the counterparties. I have never seen it occur without legal docs in place, as it would leave both parties open to significant risks. Thus I would not anticipate this to take place. Further, it should be noted that some regulators have required the transition period between March 1 and September 1 to include a backloading. Therefore, if an account is documented on July 15th, all trades from March 1st will be included at the time of document execution.
Lombard Risk: In the collateral space, documentation plays almost as an important role as that of clean data. Without appropriate and fit for purpose documentation, firms would be left exposed to significant counterparty and credit risk. Some institutions have implemented external macro based controls that actively prohibit trading in the absence of signed documentation.
Q: Do the panellists still see the silos in collateral management e.g. Sec Finance vs Derivatives. Do you anticipate this will change?
Ted Leveroni, DTCC: Every firm is different, so it is difficult to give an all-encompassing answer. However, in my view, most firms still do see silos in collateral management. That said, we are seeing some convergence and resourcing changes already, and we fully expect more strategic alignment focused on collateral in the future.
Lombard Risk: One of the biggest obstacles envisaged by institutions pertains to IT complexity in the form of product silos, multiple systems and data touch points, and a total lack of technical integration. However, the introduction of cross-product single platform collateral solutions is enabling the breaking down of product silos. This provides a holistic, cross-product view of risk, to optimise firm-wide collateral inventories. Competitive advantages such as these, are not only proving to be crucial to the success of any institution, but to the financial industry as a whole.
Q: Could you please clarify how investment managers may be affected by the margin requirement and is there a defined AUM threshold?
Ted Leveroni, DTCC: There is no AUM threshold, but there is a notional-based calculation that determines when a legal entity is subject to the phased-in IM Rules. Almost every in-scope entity, regardless of size, is impacted by the VM regulations, which require the exchange of VM in accordance with the local regulator’s specific rules and standards.
Q: Tri-party collateral management seems to be the future. Why would buy-side and sell-side firms want to build their own if their tri-party offers full collateral management, optimisation and segregated custody services?
Ted Leveroni, DTCC: Tri-party collateral is both operationally and capital efficient, while also meeting IM segregation requirements of the Uncleared Margin Rules. Some firms will begin using tri-party that have not in the past, and others will maintain their current or expanding third-party account control structure for segregation requirements, while managing collateral processing and optimization in-house or via a vendor system solution. There are pros and cons with each infrastructure solution that can be influenced by a firm’s current culture, workflow, and resourcing, and cost efficiency.
Lombard Risk: Whilst Tri-party offerings are seen as being operationally efficient, many firms would not have utilised Tri-party structures previously and thus it may be a case of “better the devil you know”. From a vendor perspective, we are also seeing a market shift towards institutions wishing to take greater control of their collateral processes, especially in the current regulatory landscape. Institutions are now under increasing pressure from their internal CRM teams to replicate the Tri-party agent calculations to ensure that there is maximum safeguarding from credit risk.
Q: As of what date and under what conditions would BOTH parties to a non-cleared transaction have to post IM?
Stephen Humenik, Covington & Burling: Under the CFTC and Prudential Regulator Rules:
- September 1, 2016 is the compliance date for IM where both the covered swap entity (“CSE”) combined with all its affiliates and its counterparty combined with all its affiliates have an average daily aggregate notional amount of covered swaps for March, April and May of 2016 that exceeds $3 trillion.
- September 1, 2017 is the compliance date for IM where both the CSE combined with all its affiliates and its counterparty combined with all its affiliates have an average daily aggregate notional amount of covered swaps for March, April and May of 2017 that exceeds $2.25 trillion.
Q: If you use a derivative prime broker (PB)—meaning you face your derivative PB, not the party you executed with—, do you need new documents for each trading counterparty for these new VM rules, or just new docs with your derivative PB?
Stephen Humenik, Covington & Burling: The Rules apply to any uncleared swaps. So the rules would apply to a back-to-back transaction with your derivative PB as well. Without knowing more about your specific situation and the structure of the documentation that you and your derivatives PB uses, both the PB-counterparty transaction and the back-to-backed transaction between you and the PB could both need VM-compliant CSAs.
Q: What is expected to happen with transaction and EMIR reporting on January 3rd, 2018? Is it a drop dead, instant switch to the new fields?
Stephen Humenik, Covington & Burling: There is no phase-in date for MiFID II/MiFIR reporting that will come into force on January 3, 2018. ESMA published guidelines (linked here) in October 2016 regarding transaction reporting for MiFID II/MiFIR, and in April 2017 ESMA published an updated Q&A and RTS on EMIR reporting (both available here).
Q: Have EU regulators confirmed that EMIR reporting will count as FCA transaction reporting, so we only need to report once? Or do we still need to transaction report our non-derivative trades?
Stephen Humenik, Covington & Burling: EMIR requires reporting of derivatives, so to the extent you have non-derivative transactions that are reportable under FCA, those would seem to need to be transaction reported.
Q: Under MiFID (what is in effect now) as MiFID II, can you explain what needs to be reported for UCITS funds? Is it only trades executed by the firm’s EU brokers, or is it all qualifying trades executed across all EU funds, trader agnostic?
Stephen Humenik, Covington & Burling: MIFID II/MIFIR generally applies to “third-country firms providing investment services or performing investment activities through the establishment of a branch” in the EU. Reporting requirements extend to products traded on EU regulated markets, MTFs and OTFs (or to which the underlying is admitted).