In a DerivSource feature, we speak to experts in the areas post-trade, regulatory compliance and collateral management about what trends or market developments they believe will shape the coming year for their firms and the wider industry. Read on for insight into what lies ahead for 2020 including the LIBOR transition, EMIR 2.2. UMR, FRTB and more.
LIBOR Transition – Only 2 Years to Go
Craig Bisson, Partner, Financial Services, Simmons & Simmons LLP
LIBOR transition will be the major issue for global financial markets through 2020 and beyond. With only two years until LIBOR ceases, there is a huge amount left for the industry to solve and some firms are still at the foothills of meeting the challenge.
There are three key aspects here: exposure in your legacy book, active trading of the RfRs and mitigating conduct risk. Technology will be required to trawl through the mountain of documents with (L)IBOR references. Our legal engineers at Simmons Wavelength have developed software which helps clients machine read tens of thousands of documents for IBOR sensitivity in a fraction of the time it would take a human. The regulators expect firms to be trading in the new rates to build liquidity and test systems.
Conversely, a strong justification will be needed for any material increase in LIBOR exposure. On the conduct side, firms should ensure that their risk framework provides for the identification and management of conduct risks, including conflicts of interest and market abuse.
As well as helping firms with project planning, training and exposure assessments, we are helping them develop their client comms and bespoke risk warnings for products. I would expect this activity to increase as firms scale-up their efforts in the New Year. There is a lot left to do!
IBOR – Focus on Fallbacks
Ann Battle, Assistant General Counsel, ISDA
In 2020, the derivatives industry will take a big step towards mitigating the systemic risk posed by continued exposure to LIBOR and other key interbank offered rates (IBORs) by implementing new contractual fallbacks. These fallbacks will give derivatives participants greater certainty and reduce the risk of disruption in financial markets in the event an IBOR ceases to exist.
ISDA will shortly finalize amendments to the ISDA Definitions to incorporate fallbacks for certain key IBORs, following several industry consultations to develop a consensus methodology for adjustments to the fallback risk-free rates (RFRs). These adjustments reflect the fact that the IBORs are currently available in multiple tenors, but the RFRs identified as fallbacks are overnight rates. The IBORs also incorporate a bank credit risk premium and a variety of other factors, while RFRs do not.
An ISDA protocol will also be published to enable market participants to include fallbacks within legacy IBOR contracts if they choose to. Both will be published in the first quarter of 2020, and will take effect three months later. The adjustments and fallback rates will be published by Bloomberg.
While the new fallbacks will reduce the systemic risk posed by the permanent cessation of a key IBOR, the adjusted RFRs will not match the relevant IBORs exactly. The derivatives industry should therefore strongly consider voluntary adoption of RFRs, well ahead of any possible cessation. We expect this trend to pick up throughout 2020.
EMIR 2.2 – Key Issues for 2020
Pauline Ashall, Partner, Linklaters LLP
Regulation (EU) 2019/2099 (EMIR 2.2) is in force from 1 Jan 2020, though some provisions will only take effect once technical standards are made by the European Commission. As well as changing the way in which EU CCPs are supervised, EMIR 2.2 will radically overhaul the regulatory position for third country CCPs that provide clearing services in the EU (TC-CCPs). In particular, Tier 2 TC-CCPs (those deemed “systemically important”) will need to comply with the same requirements as apply to EU CCPs, or demonstrate that “comparable compliance” is achieved. The Commission may also (as a last resort) decide that a TC-CCP is so systemically important that it must operate through a CCP established in the EU.
A key issue for 2020 is: how quickly the new regime for TC-CCPs will be implemented? ESMA has already consulted on the criteria for being deemed Tier 2, on “comparable compliance”, and on fees payable by TC- CCPs. The Commission is expected to issue final technical standards early in 2020. ESMA can then start reviewing whether existing TC-CCPs should become Tier 2.
On UK withdrawal from the EU, UK CCPs need to apply for registration with ESMA as TC-CCPs (also dependent on the Commission determining that the UK regime is “equivalent”). Whether it’s feasible to process applications by the expiry of any transitional period, whether any UK CCP will be required to incorporate in the EU and/or which UK CCPs will be treated as Tier 2, remains unclear.
2020: Crunch Time for SFTR Transaction Reporting
Fabien Romero, SFTR product director, IHS Markit
In 2020, SFTR reporting obligations will go live on a phased implementation timeline for in-scope firms.
While there are numerous challenges related to SFTR reporting – such as reuse calculations and data enrichment – I think it is fair to say that determining how to share unique transaction identifiers (UTIs) with counterparties in a timely manner is top of mind for the industry.
SFTR requires both counterparties to report securities lending transactions to trade repositories daily, but if they are submitted without precise UTIs, trade repositories will struggle to match the correct trades. This challenge grows considerably in transactions where multiple UTIs need to be allocated based on the number of funds contributing to the trade.
We’ve seen all of this happen with other regulations which require daily counterparty reporting, but the good news is that technology can help solve this problem. Counterparties now have the ability to share UTIs on a nearly simultaneous basis, and most importantly, prior to submitting transactions to trade repositories.
At IHS Markit, we believe UTI sharing technology can ease the burden of compliance for front and middle offices at sellside and buyside firms. We also believe that this technology enables greater data sharing and should increase the pairing rates of transactions at trade repositories.
FRTB – Trouble with Data
Tim Lind, Managing Director of DTCC Data Services
Although much of the narrative related to FRTB has focused on the complexity of risk modeling, the challenges presented by the next iteration of Basel market risk reforms are equally about access to data, availability of historic trade information, and the integrity of data governance processes. The business case for investing in the Internal Model Approach can be complex even for the largest and most sophisticated banks and much of it will come down to historical trade data and the final rules transcribed by local regulators.
2020 will mark a critical inflection point in the journey towards real reform in terms of managing risk in OTC markets. For more than two years banks grappled with uncertainty around final rules and the timing of implementation – by some estimates, banks have spent more than $20 billion complying with OTC derivatives transparency regimes focused on trade reporting. While the process has created massive reservoirs of data, reporting derivatives transactions in and of itself solves nothing.
FRTB aims for consistency and integrity in the largest and most global markets, and it would be a missed opportunity if BCBS standards weren’t adopted consistently within each country in terms of timing and framework. While data needs to be consistent and standardized, risk is always unique to each bank. FRTB was born out of the idiosyncratic risks that lurked in the tails of trading portfolios that brought the world to the brink of economic collapse in 2008. It would be another missed opportunity if the net result of OTC reform was a standard approach to market risk capital allocation that failed to leverage data that banks have invested billions to create. FRTB represents our industry’s best opportunity for some return on that investment.
UMR compliance – the 12-month journey
Shaun Murray, Managing Partner, Margin Reform
2020 is nigh and the reality for firms who are over the Phase 5 Eur50bn threshold for Uncleared Margin Rules (UMR) is that they have less than 8 months to achieve compliance for the 1st September. In practice and in Margin Reforms experience what does this mean?
The critical path depends on what has already been achieved. Outreach to dealers and clients on whether you want to continue trading with each other and acknowledge the requirements to continue to do so are paramount. You need to fundamentally agree on certain parameters particularly if you have complex group or fund management structures.
Potentially, this means a heavy documentation overhead which combined with other critical components such as a compliant collateral system, clean and digitised legal data, a custodial swift gateway, Initial Margin calculation capability, validation and governance is a heavy load.
Throw into the mix that you will eventually go live and will require business sign-off, controls, processes and procedures to support this, communication and training is a vital cog in ensuring that ‘day 1’ is a success.
In our experience UMR projects have a minimum 12-month delivery irrespective that you may regard yourselves as systemically unimportant, regulation is regulation. Working with suppliers from technology, custody, legal and UMR experienced consultancy firms to assist you on your compliance journey is a sensible choice. It should be well noted that the later you leave it to engage and work through your specific issues the more likely it is you will hit the potential bottlenecks that will occur in 2020.
Collateral Management – Reducing the Total Cost of Ownership
Chris Watts, Director & Co-Founder, Margin Tonic
In 2020 more and more firms will focus on reducing their total cost of ownership for collateral.
Recent and ongoing regulations, such as the Uncleared Margin rules, SFTR, CSDR, Category 3 Clearing and – dare I say it – Brexit, have further increased the cost of exchanging collateral across multiple products. This is due to a combination of higher funding requirements, additional fees and the need for new infrastructure, technology solutions, controls and resources.
But Collateral is experiencing the same cost pressures as other lines of business. As a result, both sell-side and buy-side participants should be proactively exploring ways to bring their total Collateral costs down.
A priority in 2020 will be for firms to re-assess their Collateral IT infrastructure costs, which can often be weighty. Here many firms have the opportunity to create a more cost-efficient target operating model.
Too many firms still maintain an expensive, siloed Collateral infrastructure, with multiple IT solutions covering different products and entities. Some legacy IT Collateral platforms have also historically been costly to maintain and upgrade.
With those points in mind, one question plenty of firms will be asking themselves is ‘should we deploy a cloud-based Collateral platform’? Cloud platforms, now supported by a variety of vendors, typically offer a reduced overall cost model for their Clients. Savings will be even greater if firms consolidate previously siloed collateral products to a single cloud-based platform.
Related cost-based Collateral focus areasfor 2020 will include single asset inventories, cross-product collateral optimisation, automated end-to-end processing, low-cost outsourcing and more.
But the big question for many firms is how do we move towards our long-term Collateral target operating model? That’s where our collateral specialists can help.
LEIs – Predictions for the Identifier in 2020
Allan D. Grody, Financial InterGroup Advisors
The LEI is a universally unique identifier to be issued to every financial market participant in the global financial supply chain. The LEI is intended as the means to aggregate financial transactions across financial enterprises and to observe the buildup of unobserved risk across globally connected financial firms.
Significant progress has been made since the LEI was first proposed in 2010:
- the issuance of LEI codes on over 1.5 million legal entities to date
- publication of studies showing significant savings to the financial industry in adapting the LEI fully, such “full adoption” projected at between 40 – 200 million LEIs
- the creation of a Golden copy database of LEIs and a delta file for LEI updates; search capabilities and an API to access LEI data; and a visualization tool to access relationship data
- the initiation of mapping of ISIN (International Securities Identification Numbers) and BIC (Bank Identification Codes) codes to LEIs
- demonstration of electronic representation of LEIs in XBRL financial reports and use of LEIs for use in secure electronic certifications
- demonstration of Blockchain for use in LEI registration
- issuance of follow-on consultations on corporate (legal) actions, fund relationships and government entities
In 2020 these activities will dominate the LEI efforts:
- Since regulatory compulsion has fallen short of full adoption of the LEI, new models for issuance has been proposed. Financial entities will be solicited to register their clients/counterparties. The largest multi-national entities’ will be solicited to register LEIs for their own complete organizational hierarchies.
- New models for the complete identity of legal entities and their immediate and ultimate parent will be explored as the complete hierarchy of LEI’s must be registered to meet risk management objectives
- Further work on Blockchain prototype will be conducted
- Promotion of the LEI’s benefits will dominate 2020
Want more? Read our 2020 preview feature “Déjà vu for 2020? Regs, Geopolitical Change, ESG & Tech Innovation to Continue to Dominate Agendas”.