Neil Murphy, triResolve business manager explores how automation can increase efficiency and maximise time savings across margin activities, delivering collateral cost reductions and allowing firms to focus their attentions on higher-value activities.
New uncleared margin rules (UMR) require in‑scope users of over-the-counter derivatives to post and collect initial margin (IM) – in addition to the current exchange of variation margin (VM) – and are expected to have a long-standing operational impact. As a minimum, firms will be required to manage increased data flows and margin calculations, while firms that exceed regulatory thresholds face an increase in the number of margin calls and settlements they must perform. In some cases, this will lead to call volumes tripling as firms move from managing one daily margin exchange per portfolio (VM) to three (VM as well as two non-netted regulatory IM calls).
Firms impacted by earlier UMR phases typically focused on calculating IM, as well as other upfront tasks such as custodian onboarding and legal documentation. Collateral management and downstream impact were frequently considered secondary priorities. However, firms in-scope through phases one to four included many of the largest firms. Typically, these firms already benefited from high levels of margin automation, which largely explains why they were relatively less concerned about additional operational impact on collateral.
Ahead of phase six, the key question is whether smaller firms in phase six have the levels of operational capacity and automation to cope with UMR.
Regulatory relief means phase six’s impact on firms will vary – some will be required to post IM soon after the compliance deadline, while for others this may take years, if it happens at all. Even those that expect minimal impact must ensure they can support additional challenges around calculation and IM monitoring, while others must prepare to support the complete IM collateral flow. Regardless of the expected impact, phase six firms must urgently review their entire end-to-end collateral flows for both IM and VM.
Manual processes for collateral management are nothing new. In a 2017 paper, the International Swaps and Derivatives Association (Isda) noted pain points across the margin lifecycle, from VM calculation and call processes, to asset selection and collateral settlement, to margin interest calculation. The paper describes “antiquated, legacy processes that require substantial updates”, and recommends “automation of the front-to-back collateral process allowing for a virtual zero-touch environment”. Five years on, how much of this work has been completed by phase six firms?
For many, operational processes have remained largely untouched for years, characterised by the manual calculation and exchange of margin calls. Reliance on emails for margin call exchange can lead to lengthy processing times, increased risk of user error and higher costs. In addition, the settlement process is often disconnected from the margin flow, requiring additional manual processing and increasing the risk of settlement failure. While the European Market Infrastructure Regulation and Dodd-Frank rules have done much to mandate portfolio reconciliation, some still deviate from industry norms and the use of shared platforms, increasing not only their own operational efforts, but those of their counterparties too. It is likely many of these firms are still some distance from the zero-touch processing Isda called for in 2017.
For many, back-office changes have not been a priority to date because of competing priorities, a feeling that volumes haven’t necessitated an overhaul and a historical perception that the project and technology costs required for change are perhaps more expensive than operational costs.
However, phase six firms should learn from those impacted by earlier phases. Successful UMR compliance is about much more than IM calculation and, wherever possible, firms should use the regulatory deadline as an opportunity to transform and upgrade their collateral operations capabilities. While UMR may not mandate collateral automation, business demands may require it. UMR compliance will require a new focus: firms must support larger operational volumes, shorter settlement windows, larger amounts of collateral being exchanged and, for many, a switch from cash to securities collateral, as well as new requirements to segregate collateral.
For some, existing operational weaknesses were highlighted by the Covid‑19 pandemic, where dependency on manual processing required more bodies at desks. This is in contrast to firms with high levels of straight-though processing (STP), which were able to transition to remote working more quickly. Similarly, these firms are often those most stretched during periods of market volatility as margin call numbers increase quickly.
In reviewing the lessons learned from earlier phases, many firms took a proactive approach, using the regulatory deadline as an opportunity to drive operational and technology changes. For many, this focused not only on changes to meet new IM tasks, but on broader transformation that updated their wider VM and dispute capabilities. The consistent theme has been that many firms recognised a need to improve their existing infrastructure and operations to support the expected increase in volumes – whether driven by new agreements, calculations, margin calls, settlement or simply monitoring new IM exposures.
What does collateral automation look like?
Automation can mean different things to different people and, historically, some may have been satisfied that an emailed margin call was sufficiently ‘automated’. However, it is important that firms take a broader industry-wide view to understand the full potential for automation.
Taking the negotiation of new IM legal documentation as a starting point for UMR, this can already be negotiated via the Isda Create portal, allowing firms to move away from the legacy exchange of drafts and amendments via email. While the IM calculation itself may be owned by the risk department, firms must ensure this flows directly from the risk engine to the collateral system, allowing firms to automatically monitor exposure (where IM remains below €50 million) or calculate any margin requirements due. An integrated technology approach – often from a single provider – can reduce integration points and deliver more STP.
A margin call workflow is another essential tool, providing not just a robust approach to managing calls, but ensuring a clear audit trail too. Central to firms’ workflows should be the use of electronic messaging to exchange calls – email should be used as a last resort. To date, margin messaging has been the norm for exchange of IM calls in earlier phases. Messaging allows firms to maximise STP, supporting real-time exchange of margin calls, which, when combined with workflow automation, means margin calls can be completed in seconds rather than hours. A move away from manual processing should allow firms to automatically send and agree calls and, where required, identify key IM and VM dispute drivers.
The final step in the margin lifecycle is collateral exchange and settlement, which is typically constrained by a manual process to select and pledge collateral, and is further limited by reliance on legacy settlement processes – which, in many cases, still depends on the use of fax or manual booking of payments. Automation enhancements should include leveraging the system to optimise and book collateral movements, as well as synchronising the margin and payments workflows, using Swift for instruction of payments. Not only will this ensure STP and lower the risk of failed payments, but it will increase transparency by providing real-time settlement status – allowing firms to move away from assumed settlement – and the capture of tri-party collateral allocations.
The path to automation
Recent technological advances and broader adherence to industry standards mean the entire margin process can now be automated. Rather than build custom automation, firms can leverage shared infrastructure to fast-track this journey. This approach ensures firms can stay up to date, with immediate access to the latest features, ensuring automation across the margin lifecycle, including connectivity to risk engines, counterparties, reconciliation platforms and custodians.
In addition to the obvious time savings automation can deliver, it can also help firms reduce processing costs and is a critical step towards optimisation – which can itself deliver further collateral cost reductions. From a user perspective, automation can help teams focus on higher-value activities and – by removing the legacy of manual processing – can lead to higher rates of job satisfaction.
The time to act is now
Used wisely, automation can deliver increased efficiency and greater time savings across all margin activities. By focusing on the entire collateral process – rather than purely IM – firms can achieve quick returns on their current VM processes, creating more bandwidth to help prepare for UMR and cope with increased challenges after the September 1 deadline.
Tools to help firms solve these common problems are widely available, while greater use of shared services and industry standards means the cost of change may quickly be recouped.