By Chris Walsh, CEO of Acadia
Uncleared Margin Rules (UMR) implementation has been going on for over nearly a decade and it has provided the over-the-counter (OTC) derivatives community with a level of structure and guidance. Having entered the final phase of UMR in September last year, a new, unofficial seventh phase for compliant firms begins, one that is driven by a push towards Optimal Margin Management (OMM).
While the UMR process has put an industry-standard initial margin (IM) workflow in place, a natural next step is seamlessly integrating this IM workflow and the broader risk and collateral management platforms. However, many firms that needed to meet tight compliance schedules had no option but to separate the margin process by implementing IM without ideal integration, using separate service providers, which results in more inefficiencies and inaccuracies.
To address these challenges, a whole new set of services has evolved, providing a framework upon which a broader, integrated margin ecosystem is being built.
There’s a number of reasons why OMM is required.
- IM exposures are too high. Many firms have implemented the standard initial margin model (SIMM) to comply with UMR but in doing so have taken on too much IM exposure and are locking up too many assets in collateral.
- Funding costs are on the rise. In the low, zero and negative rate environments we have experienced in recent years, the cost of collateralising these exposures has been less of a concern. This is changing quickly in today’s rising interest rate environment where firms have seen funding costs rise as much as 150%.
- Dispute levels are too high. This is resulting in unsustainable dispute rates, a condition that cannot persist under the new regulatory environment.
- Technical debt is too high. For many firms, compliance has resulted in additional technical debt due to rushed, deadline-driven developments and fragmented environments and data.
- UMR is no longer a project, it’s the new business as usual (BAU). Many firms who viewed UMR as a one-time process leveraged on-time project team resources to conduct activities, such as annual scoping and onboarding, that now must be done on a continuous basis. Without a focus on OMM, there is a significant risk of not only becoming less optimal over time, but also of falling out of compliance.
Under OMM, the new risk calculations and operational workflows initially implemented for compliance with UMR are streamlined and these optimised calculations and flows are automated, and therefore more accurately sustained on a go-forward basis within the market participants’ business-as-usual environment. Assuming all data is accurate, OMM brings about seamless workflows as validating risk is more ready to assess market and counterparty risk, and satisfy any regulatory conditions.
An OMM framework of optimising, validating and enabling is presented where optimising helps increase efficiency by minimising the amount of IM firms are posting and/or reducing the cost of collateralising the exposure. There are a number of different methods that can be leveraged to do this, including pre-trade analysis, portfolio optimisation, threshold management, and collateral optimisation.
Validating mitigates risk through assessing market and counterparty risks and, in many cases, satisfying regulations. A number of methods that can be leveraged to validate includes model validation and governance, back-testing and benchmarking, liquidity stress testing, analytics and crowdsourcing, and other regulatory compliance services, for example securities-backed broker dealer regime in the US.
Enabling facilitates seamless workflow through ensuring data is accurate. Under UMR, surprise data inaccuracies could require data trading to be halted between counterparties, which can also result in write downs, disputes and even regulatory issues.
OMM is ultimately realised when quantitative risk and operations are brought together in a way that day-to-day margining decisions seamlessly balance risk and performance impacts. Unlike the UMR implementation phase which was organised in six phases each with fixed deadlines, OMM is more continuous and for many firms is likely to involve a series of prioritised steps.
At the same time, new IM functions need to be mainstreamed across firms – across trading, risk, operations and settlement.
If this is not done effectively, firms risk breaching thresholds (and having to stop trading with key counterparts), locking up too much capital (and thereby reducing trading capacity) or seeing funding costs rise beyond acceptable levels.
Found this useful?
Take a complimentary trial of the FOW Marketing Intelligence Platform – the comprehensive source of news and analysis across the buy- and sell- side.
Gain access to:
- A single source of in-depth news, insight and analysis across Asset Management, Securities Finance, Custody, Fund Services and Derivatives
- Our interactive database, optimized to enable you to summarise data and build graphs outlining market activity
- Exclusive whitepapers, supplements and industry analysis curated and published by Futures & Options World
- Breaking news, daily and weekly alerts on the markets most relevant to you