To slow the spread of COVID-19, governments worldwide have been mandating enormous societal shifts, from requiring those who can to work from home, to shutting all non-essential businesses, slowing down economic activity. The markets have, of course, responded, and Collateral and Ops teams have naturally been intently focused on business continuity and managing the severe volatility. That is a significant challenge in itself but for those in scope in Phase 5 and 6 of the Initial Margin rules, there has been the additional challenge of how to juggle resources between increased BAU activity and the upcoming regulatory deadlines.
However, it seems there may be some reprieve. BCBS-IOSCO announced late on Friday that Phase 5 and 6 were to be delayed by a year respectively, potentially buying some valuable time for those firms affected. It should be noted that local regulatory bodies now need to ratify this guidance in underlying local rules to make it apply, which is very likely to happen. In that case, firms have a new landscape to assess and solve for.
Our viewpoint is that in times of incredible market volatility like those we’re currently experiencing (where one-day moves can be as big and sometimes bigger than the 2008 global financial crisis), it is imperative for a Trader or Risk Manager to have adequate collateral to access in the event of a counterparty default. Variation Margin (VM) covering mark-to-market (MTM) losses up to the point of default may be insufficient in highly volatile markets and low liquidity, leading to potential losses after counterparty default. However, if firms and risk teams have Initial Margin (IM) to cover them for potential portfolio losses for the 10-day period after default, the level of counterparty risk in their trading books would be mitigated as they have a comfortable cushion to fall back on.
In addition, firms we’ve talked to have indicated that there has been a significant amount of work already done to prepare for IM compliance.
Therefore, we believe there is great merit (and potentially far less risk) in pushing ahead and completing an Initial Margin implementation as soon as possible, especially for those who have put in a large amount of groundwork thus far in anticipation of the original Phase 5 and 6 compliance dates.
However, we also get that UMR comes with pain. It involves two-way posting, and it has an associated cost of funding and potentially a good amount of operational complexity. But all in all, wouldn’t Traders and Risk Managers prefer to know there is capital to play with in the event of a counterparty default?
We believe so.
Some of us at CloudMargin were working as leaders of these types of teams during the 2008 financial crisis. Our CEO Stuart Connolly, who was Managing Director in the Securities Division at Goldman Sachs during that time, said: “I oversaw some pretty large losses in 2008. Pretty much all of those losses would have been offset by IM, if we had it!”
As a reminder, we have partnered with AcadiaSoft to offer the industry-leading front to back platform for Initial Margin. Easy to implement, our platform enables firms to set-up an IM process quickly with minimal effort (and more) with the following features:
Our highly automated workflow calculates IM pledgor and secured amounts using ISDA SIMM or Schedule based exposure calculations and allows you to agree these electronically with your counterparties.
Our eligibility model validates asset selection against client configurable concentration limits and wrong-way risk checks to confirm compliance. Where applied, we combine these validations with automated inventory selection to place assets.
Our platform supports both Triparty and Third Party settlements models via our own SWIFT gateway, DTCC MTU and client-defined settlement systems.