Many firms captured in UMR Phase 6 are probably now breathing a sigh of relief that they have managed to get all their systems and processes in place, and were ready for the go live on September 1st.
But the work doesn’t stop there. Supporting UMR is an ongoing task and priorities will change over time. For many, the September 1st deadline was about doing enough to make sure that they could go live, but not much more, on the assumption that initially they will be below the $50 million threshold and therefore will not need to exchange margin.
However, that is not going to stay true forever. Firms need to decide what they are going to do as their margin requirements increase in the coming months.
Some firms have decided that, at least initially, they will rely on their counterparties’ calculation of margin numbers. This may have been expedient for going live, but experience from Phase 5 has shown that there has been a lot of confusion over the numbers being generated by brokers and therefore firms have quickly moved to calculating their own numbers.
If this is you then you may want to start implementing a solution sooner rather than later. It will give you the opportunity to question the margin being calculated on your account, as well as allowing you to move on to more advanced functionality, such as optimising your margin, in the future when you reach the point of exchanging collateral.
As trades are added to a portfolio then the margin under UMR will increase. This could be based on a number of factors such as new trades based on existing strategies, or deciding to start trading additional instruments to gain exposure to new risks,
The recalibration of SIMM by ISDA has also shown how margin can suddenly increase without any change in a portfolio. Some firms already within the scope of UMR have seen their requirements go up by around 30%; the sort of increase that could easily see margin jump above the $50 million threshold for a smaller portfolio.
With the potential for rapidly rising requirements, there are a number of things that firms should be concentrating on now that any initial implementation has been completed:
- Monitoring is key. Firms need to make sure that they understand how new trading is impacting their margin and how quickly they are reaching the point where collateral will need to be exchanged.
- If not done so already, on the assumption that initial requirements would be below the $50 million level, now is the time to sort out the arrangements with counterparties for exchanging collateral.
- Rising interest rates, leading to increased funding costs, means that firms should also be looking to optimise their margin, making sure that they’re not paying any more than needed.
As margins increase, having access to a monitoring tool becomes key. Being able to assess how quickly you are approaching the $50 million threshold means you can be well prepared for exchanging margin, with all the necessary funding and documentation in place.
At the same time you can validate the margin that counterparties are calculating on your account. This could identify issues that need to be addressed to ensure that when margin is paid it is the correct amount. It might also identify any multipliers that brokers are applying to the margin being calculated, which may be in addition to any multipliers that they are already charging on cleared positions. If you want to know more then read here: PRA review of the SIMM model: Impact on margin requirements
If you are nearing the $50 million threshold and given the potential funding costs of covering margin requirements, then looking at ways to optimise your margin is something that you can’t ignore. There are various means of doing this, so having a solution that can assess all the possibilities is important.
If the intention is to continue trading bilaterally, then it is worth considering where the risk is placed. A change of counterparty may be enough to lower the requirements, improving any netting benefits that are available for the portfolio within the SIMM algorithm, as well as making best use of available thresholds.
Alternatively, it could be advantageous to consider moving from bilateral to cleared. Many CCPs have realised that there is an opportunity here to increase flow by looking at ways to make it easier to trade the same risk, but using cleared rather than bilateral products.
To Do List
You may have managed to be ready for UMR Phase 6 go live, but now is the time to get yourself in the best possible position going forward:
- If not doing so already, implement independent margin calculations so that you can validate the amounts that brokers are charging.
- Ensure you can monitor your margin requirements so you know when you are going to reach the $50 million threshold.
- Make sure you have the arrangements in place to exchange collateral with counter-parties.
- Implement a solution to help optimise margin by suggesting alternative ways of trading the same risk but with a lower margin requirement.
It’s important to realise that the September 1st deadline was just the start of the impact of UMR Phase 6.