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Are Asian Buy-Side Firms Prepared for UMR Phase 6?

With less than a few months to go before the implementation of Phase 6 of the BCBS-IOSCO Uncleared Margin Rules (UMR), in-scope buy-side firms should now be in the advanced stages of their preparations. Firms that fail to meet their margin requirements under the new rules will incur regulatory fine.  

UMR’s upcoming Phase 6 will lower the average aggregate notional amount (AANA) threshold for firms to be in scope to $8 billion – this will be implemented in September. This lower threshold means that more market participants will be impacted by the rules—between 700 and 1,200 additional firms globally, a significantly larger number than the estimated 300 firms which were in-scope for Phase 5. 

GlobalTrading spoke with DTCC’s Bob Stewart, Executive Director, Institutional Trade Processing, on the importance of getting ready for compliance. The interview is below:

Bob Stewart, DTCC

Phase 6 of (UMR) is due to be implemented in less than six months this September. Phase 6 will lower the AANA threshold for buy-side firms to be in scope to $8 billion, firms that fall into this category need to allow ample time to prepare. From your perspective, are Asian buy-side firms ready for this implementation?  

As with all other regions, the majority of firms that will come into scope under UMR Phase 6 are relatively smaller firms (at least in terms of their OTC derivative usage) with potentially limited middle- and back-office resources, and lower levels of automation.

This may impact their ability to manage the range of tasks required to ensure compliance with UMR. Comparing where firms were at this stage in previous UMR phases, it seems apparent that these smaller Asian buy-side firms are moving more slowly this time. 

This could be due to the fact that, in many cases, the firms believe that it will take a considerable amount of time before they breach the initial margin (IM) exposure thresholds that would require them to post margin.

However, these firms should consider changing strategic or economic circumstances might potentially alter their future trading patterns, thereby impacting the time taken to breach initial margin exposure thresholds.

Should buy side firms in Asia start preparing now for Phase 6 of the UMR and what kind of timeline will buy side firms need to be ready?  

Once a firm has established that it is in-scope for Phase 6 based upon the $8 billion AANA threshold, it needs to identify its key trading counterparties – the firm’s key counterparties should be prioritized since these organizations will most likely reach the $50 million initial margin (IM) threshold for exchanging collateral.

It is a very good idea to contact key trading counterparties to agree how IM exposure will be calculated, monitored, and compared. Once the key trading agreements have been identified, and firms start to calculate and monitor exposure, then firms will have a sense of the number of new collateral agreements and custody accounts that will be required.

The papering of new agreements, and the custodial account opening processes will require significant time and specialist resources.

Phase 6 of the UMR will force buy-side firms in Asia to install new systems, processes, documentation, and custodial relationships, to stay in compliance. Can you talk about this in more depth? What kind of processes and technologies need to be executed to ensure compliance?  

UMR stipulates 2-way margining; that is, both parties call for margin from each other. 

The exposure calculation which underpins this is completely different from the netting of trade PVs which underpins variation margin. Firms can choose between approved calculation methodologies (such as ‘SIMM’ – standard initial margin model – or ‘Grid’), and can further choose to submit portfolio data to a vendor and have them calculate the exposure.

Firms should prepare to calculate and compare exposures with their counterparties in order to identify and resolve differences in approach before they are required to deliver margin to each other. Ultimately, firms should prepare to resolve any IM disputes in the same way as they do today for variation margin. 

UMR also stipulates that collateral posted in respect of IM is held in segregated accounts at third party custodians. When IM thresholds are breached, and margin is set to be posted, firms will be required to have already opened such accounts at either traditional or triparty custodians, to have informed their counterparties of all relevant operational details of these accounts, and to be ready to send settlement instructions to these accounts.

You have said that it is of crucial importance that the lower average aggregate notional amount (AANA) threshold of $8 billion will bring smaller firms into scope, which typically have fewer middle and back-office resources and differing levels of automation. What can they do to prepare for phase 6 of UMR? 

Firms who were impacted by previous phases of UMR have taken widespread advantage of services developed by established providers. As well as providing tried and tested processes and systems, these are services with which the sell-side is comfortable and is ready and able to support with Phase 6 firms.

While it is possible for smaller firms to attempt to perform all their own calculations and process monitoring, it really makes life a lot easier if firms use the tools that already exist and with which their counterparties are familiar. In addition, firms should act as soon as possible to understand onboarding requirements both their own, and their counterparties’ custodians.

The legal and documentary requirements are non-negotiable. However, operational connectivity is another area which can be solved by established utility providers. Firms should, where possible, avoid reinventing the wheel when it comes to building their own solutions versus considering what is already available.

How will these enhancements allow Asian buy-side firms to be able to use their available collateral more effectively

Using existing services to calculate and monitor IM exposure will reduce the scope for disputes and improve efficiency in terms of prompt agreement of exposures.

Automation of the margin call and settlement processes will also reduce operational inefficiencies and allow for easier identification and reconciliation of collateral deliveries and recalls.  

Is there anything else important that buy-side firms in Asia should account for concerning Phase 6 of UMR? 

With UMR Phase 6 less than six months out, time is of the essence. Ensuring readiness for the mandate can be a time-intensive undertaking, but this is made easier by working closely with key counterparties and custodians.   

Adoption of existing automated solutions should be considered as these are widely recognized by the sell-side.