CloudMargin’s Industry Insight Series has been specifically created to shine a light on critical areas and themes within the financial services industry. Once a month, we will showcase expertise and viewpoints from industry figures who will highlight and discuss important areas in the market. The series has been designed to educate, inform and help you better understand complex issues within an ever-changing financial landscape.
Nick Railton-Edwards, DRS LLP
A trader turned lawyer, Nick Railton-Edwards is Head of Research at Derivatives Risk Solutions. Specialising in Financial Regulation, the team develops tools to help clients profit from change. Aside from personal property and oyster-farming ventures, he brings practical insight to the role from a previous 15-year career as a senior derivatives trader a number of investment banks.
Margin rule compliance – A mountain still to climb
With a scant five business days to go before expiry of the uncleared margin rules VM deadline, it seemed fitting to take a look back at the progress the industry has made since the eve of 1 March – only 40% of market participants had achieved compliance as of that date – and to also touch upon the regulations constantly looming on the horizon.
Many readers will recall the potentially disastrous implementation of both IM and VM so far. Phase 1 IM hit a custodian onboarding bottleneck, restricting first-day trading to an estimated 30% – 35% of the normal market. Meanwhile, the whole European side of IM phase 1 was delayed for over four months by political infighting. The “Big Bang” global rollout of VM phase 2 resulted in a six-month “forbearance” period by regulators – another delay which based on past experience should have seemed inevitable.
The intervening time has been used to good effect, with ISDA estimating that 90% of the market has now achieved compliance with the VM regulations. Trades executed post 1 March under the remaining 10% of unamended CSAs are likely to be unwound, and trading with non-compliant counterparties will be halted from 1 September.
To misquote Churchill, the (finally) fairly successful implementation of both IM and VM rules so far is not the end. It is not even the beginning of the end, with a steep mountain still to climb. But it is, perhaps, the end of the beginning.
The (again delayed) deadline for the inclusion of Forward FX transactions in Europe expires on 3 January 2018. Work on initial outreach to this significant number of counterparties, many of which until now have been entirely untouched by margin requirements, has already begun. The six firms included in IM phase 2 are currently completing negotiations for their 1 September deadline.
Even with such a low number of newly in-scope entities, it is clear that IM implementation represents a challenge. Rather than negotiating one document, as per the VM CSA, IM compliance demands the simultaneous negotiation of between 5 and 6 documents, with which the wider market is wholly unfamiliar. IM knowledge is concentrated in the small number of banks who comprise phase 1 and 2 and the handful of consultancies and law firms who were instructed to assist them.
While numbers remain uncertain, it is estimated that phase 3 IM will bring another 120 – 150 entities into scope. Although the 1 September 2018 deadline seems distant, the task is already looming large in the distance. While the majority of these counterparties will be familiar with the systems and processes required for the daily exchange of VM, IM, in contrast, requires a step-change in legal, risk management, and operational capabilities. There will be no IM protocol, though given the VM equivalent’s abject lack of impact, this would have been unlikely to afford assistance.
The lessons to date are clear.
Start early – Cleanse and aggregate the necessary data, decide on your fundamental negotiating positions, reach out to your counterparties for their own elections.
Improve coordination – IM’s complexity involves a higher degree of coordination with internal and external stakeholders than previous margin implementations; consult, inform and agree with them all.
Do not rely on regulatory delay – While common, delay merely defers the deadline, and it is not a given.
Do employ subject matter experts where possible – Many IM variables can be outsourced to specialist firms. Initial document negotiation and ongoing collateral management are the two most “technical” elements of IM implementation, and each lends themselves well to partnership with outside firms.