Approximately 250 firms, including many more buy-side firms, could fall into scope for Phase 5 of the Uncleared Margin Rules (UMR), according to AcadiaSoft’s estimates. At the same time, firms will need to be prepared to address variations of the Initial
Margin (IM) rules that may play out differently in Europe than in the U.S. AcadiaSoft will take a deep dive into one aspect of these differences in processes across Europe & the U.S. during our webinar on Wednesday, November 13 at 3pm GMT/10am ET (sign up here).
In the meantime, following is a summary of the challenges and potential solutions for IM phase 5 and 6 firms.
Many buy-side firms caught up in IM phase 5 or 6 may already be posting discretionary IM to their dealers where the dealer has agreed to be calculation agent for the margin call. These buy-side firms likely won’t have large operational staffs and will already
have a process in place for validating the dealer-provided discretionary IM margin call. As a result, it will only be natural that if these firms must move regulatory IM, they consider asking their dealer to be calculation agent for the regulatory IM call. Firms
that do not exceed the €50m IM threshold by dealer counterparty group, on the other hand, will undoubtedly look to leverage the IOSCO guidance that allows them to delay their operational readiness to move
The question buy-side firms need to address is whether the process, policies and procedures they have in place for validating discretionary IM will meet theirs and regulator validation needs for regulatory IM. To support buy-side firms, AcadiaSoft has developed
an IM Sole Calc service and is developing an IM Threshold Monitoring service, both of which will complement the full IM Exposure Manager, Sensitivities Calculation and Backtesting and Benchmarking services.
IM Sole Calc will allow in-scope IM Phase 1, 2, 3 and 4 firms to supplement their existing regulatory IM margin call data feeds with expected call information. This will provide the in-scope IM Phase 5 and 6 firms with a central view of both incoming
Reg IM calls sent by dealers as well as their outbound Reg IM call (created from the dealer expected call).
IM Threshold Monitoring is being developed specifically for IM Phase 5 and 6 firms who don’t yet want to make an operational investment because they won’t immediately exceed the €50m IM threshold. IM Threshold Monitoring is a free service provided
by AcadiaSoft that will allow firms to view their estimated IM exposure across all their dealer counterparties in one place and monitor anticipated exposure versus expected threshold to ensure adequate time for preparation to move margin, should it be necessary.
U.S. vs. EU
In the U.S., under UMR, it’s the prudentially regulated firms that have the requirement to collect and post IM, which is how the buy-side gets affected by the rules. When a U.S. sell-side firm trades with a U.S. buy-side firm, U.S. regulators are
perfectly comfortable with the IM exposure calculation and monitoring requirements sitting only with the prudentially regulated firm.
However, in the EU, because both sell-side and buy-side firms fall directly in-scope for UMR via the definition of a “financial counterparty” under the regulation, the ability for an EU buy-side firm to use their dealer as calculation agent for regulatory
IM is much less clear.
To provide more clarity to IM Phase 5 and 6 firms, AcadiaSoft spoke to the appropriate regulators on this topic and learned that it’s fine for an EU buy-side firm to outsource the calculation of initial margin to a vendor, a fund admin or their dealer
counterparty as long as the buy-side firm retains the responsibility for validating the accuracy of the result calculated by the external provider.
By extension, the question then becomes what qualifies as adequate validation? To help move the discussion along, we’ve identified a range of validation options available to firms arranged from least to most expensive to implement and maintain. This is not
meant to be an exhaustive list of options – there may be other sound validation options that we haven’t considered. It’s also important to note that when documenting policies and procedures that could be subject to regulatory scrutiny, firms should always
defer to the opinion of internal and/or external counsel.
For a buy-side firm that wants to use the dealer regulatory IM calculation agent approach, there are several options:
- Perform a day-over-day comparison of dealer expected call amount. If IM Margin call is within expected $$$ or % threshold, no investigation is required. If large day-over-day swings are observed, ask your dealer to explain the cause of day over day
difference to your satisfaction.
- Same as above, but also revalidate source data and the math used by the dealer to calculate the regulatory IM Margin call (i.e., exposure, less threshold, less collateral, less MTA).
- Same as 1 and 2 above, but license AcadiaSoft’s IM Sole Calc Premium service to view dealer IM exposure summary and associated details by product class and trade.
- Same as 1, 2 and 3 above, but also use the Schedule IM calc to proxy what range the ISDA SIMMTM IM exposure used in dealer margin call calculation should fall within.
- Calculate Sensitivities and ISDA SIMMTM and reconcile IM exposure via AcadiaSoft’s Initial Margin Exposure Manager (IMEM). This provides complete transparency over the calculation itself and also performs a daily reconciliation of buy-side’s exposure
numbers to the firm’s dealer counterparty.
Generally speaking, there are three calculation options for firms that choose the last option:
- Calculate IM exposure yourself (the most expensive option – includes the cost of the initial build and then the ongoing quant, tech and annual maintenance costs)
- Use a fund administrator (less expensive than doing it yourself)
- Use a vendor like AcadiaSoft (the most cost-effective option)
The five options outlined above cover a wide range from very light touch to belt-and-suspenders. Determining the best option will ultimately come down to a variety of factors, including which jurisdiction the firm is in, the firm’s interpretation of the
applicable regulations, the firm’s risk assessment and the firm’s in-house capabilities.
Disclaimer: The opinions noted in this article are those of the author and AcadiaSoft. This Blog/Web Site/Commentary should not be used as a substitute for competent legal advice from a licensed professional attorney.