July 11th saw HFM’s Breakfast Briefing on Uncleared Margin Rules (UMR) take place in New York, with panelists from Seward & Kissel, BNY Mellon, KPMG and OpenGamma joining to explore how to best prepare for the next phase of UMR.
The briefing began with a discussion on AANA calculations, with each panelist sharing what they had seen working with market participants who were currently one month into the three-month daily calculation period in the US. Issues around jurisdiction differences for global funds and ambiguity on certain derivatives products such as options were discussed, with all parties agreeing that calculating AANA is a challenge in itself.
The discussion then moved onto the challenges of calculating regulatory margin — both from an operational perspective and a quantitative perspective. The panel gave an end-to-end description of the core requirements — touching on a range of points from the challenges of generating sensitivities and the CRIF file for SIMM, all the way to re-papering with 3rd-party custodians and the importance of model governance.
The following points were brought up:
- Re-papering custodial agreements is a lengthy process and should be done sooner rather than later — particularly for Phase 5 where there is expected to be over 9000 agreement negotiations taking place. Panelists concluded that firms should aim to have everything in place by the end of 2019 for a September 2020 capture date
- Calculating SIMM is challenging from both an operational and expertise perspective: Panelist reported that many firms that originally intended to build-out their own SIMM-related infrastructure quickly realised that the sensitivities and CRIF generation is a large undertaking for two reasons:
Firstly, the sensitivities/risk-bucket mapping are different to their existing view of risk, so require an entire new framework.
Secondly, the biggest problem created by regulatory IM is not the upfront build but actually allocating quantitative resources to day-to-day reconciliation.
- The choice between SIMM vs schedule-based IM (Grid) is not straightforward: While Grid is easier to implement, it is more punitive in almost all cases. However, calculating SIMM — especially on exotic products — requires significant quantitative resources although margin requirements are likely to be lower.
There was debate around the requirement for a firm to repaper given the allowance of a $50m regulatory threshold. Calculating SIMM on today’s portfolio is only indicative of the level of IM that will be incurred after September 2020 — given that UMR does not apply to legacy trades before this date. For this reason, firms may be able to optimise their trading to avoid ever exceeding $50m per counter-party and therefore would have no need to set-up the infrastructure to post regulatory IM. On the flip side, feedback among the panel was that banks will expect all infrastructure to be in place, even if the account is left empty for its entire existence.
Following on from the discussion about the $50m threshold, the panel alluded to the optimisation opportunities that are created:
- Opportunities to voluntarily clear eligible products such as inflation swaps and non-deliverable forwards are increasing.
- Having pre-trade tools in place to simulate the impact of adding new trades in a regulatory IM environment are crucial to minimising margin requirements.
- Voluntarily backloading bilateral trades can be a mechanism to reduce IM as risk offsets decrease margin requirements under SIMM.
The panel concluded the discussion by talking about what was learnt from Phases 1-3. Everyone agreed that in general the market had underestimated the work involved and therefore left implementation to the last minute, causing a rush in the run-up to the go-live dates. In addition to this, the panel brought up that for Phases 4 and 5, the types of firms that are captured are smaller and less sophisticated in nature — so the reliance on external services is inevitable and should be addressed sooner rather than later.
Questions from the audience centred around issues in reconciliation between hedge fund and counterparty calculations. The panel spoke about some of the examples they have seen. These included:
- Model differences in swaptions
- Curve calibration differences for swaps
- Inconsistent risk bucket mappings for equity TRS.