Today (1 September) is go live for Initial Margin (IM) Phase 5. Hundreds of new counterparties are now in scope of the margin rules for uncleared derivatives in a milestone that was supposed to happen a year ago but got put back due to COVID.
As we warned in our Olympic regulatory round up piece a month ago, plenty were not fully ready with signed IM documents and custodial arrangements in place. There was just too much legal and operational work with other priorities weighing on people’s time.
However, there is some respite in the short term in the form of ‘Threshold Monitoring‘. As long as you don’t exceed €/$50m in calculated initial margin at group level, then the IM obligations do not kick in. Counterparties, either as a result of running out of time, or as a deliberate strategy as they don’t think they will get near the threshold, have put in place monitoring.
Of course, this could be a risky strategy as market conditions might rapidly change leaving counterparties unable to trade bilateral swaps and in regulatory non-compliance.
First of course is to finish Phase 5 – work continues between legal and collateral operations teams to tidy-up remaining relationships that need to be documented. But with that done the fun is not over, as focus will rapidly shift to Phase 6 – FCs1 and NFC+s2 with AANA (Aggregate Average Notional Amount) in uncleared derivatives above €8bn (down from the Phase 5 level of €50bn). Phase 6 deadline is a year from now, 1 September 2022.
And what have we learnt?
Just to reflect on a few themes that emerged during Phase 5, and no doubt will continue to manifest as we move into Phase 6:
- Custodians: there are long lead times for setting-up new custodian arrangements that as much as anything dictate the eventual timelines for completion. And extra time is needed for Know Your Customer/onboarding if new custodians are involved.
- Scope: working-out who is in scope of the new rules is not trivial, especially given thresholds are applied at consolidated group level potentially across multiple operating entities; confusing factors like FX deliverables contributing to AANA but not being IM products adds to the complexity.
- Standardisation: there is a lack of industry standards, e.g. for threshold monitoring...at what levels, how documented? Also standardised SWIFT messages from custodians for settlement. There is likely scope to streamline the whole documentation and operational process to improve end-to-end timelines.
- SIMM3 v Grid4: the methodology for calculating expected collateral levels...generally SIMM was used in the past, but increasingly with directional portfolios, or as a result of operational constraints for some products/counterparties, Grid being used now as well (see ISDA’s paper for more on this).
- Cross jurisdictional: entities outside uncleared margin rules drawn into scope by facing entities subject to the rules, but are more reluctant to engage; also the possible divergence in rules e.g. between EU and UK post-Brexit may present challenges in the future.
All in all, it has been a bit of a scramble to the 1 September 2021 finish line, and quite a few will limp across the line after the race is over, but broadly due to Threshold Monitoring we are unlikely to see substantial disruption to trading activity in the near term.
Time will tell whether all can keep within their agreed limits, and how things will start to play out as the industry gears up for Phase 6.