OSTTRA won the Collateral Management Solution category in the FOW International 2021 awards.
Speaking in late January 2022, some seven months before the introduction of the sixth phase of the Uncleared Margin Rules in September, Neil Murphy, business manager OSTTRA triResolve, and Gemma Bailey, business manager OSTTRA triCalculate, reflect on the challenges posed by the next wave of margin reforms.
Neil Murphy, business manager OSTTRA triResolve, OSTTRA, said: “At a high level, the rules effectively introduce a requirement for firms that trade on a bilateral OTC basis to exchange initial margin, effectively moving the bilateral world closer to the cleared space. It’s quite a jump for firms. Those firms that clear today may be familiar with initial margin, albeit using a different model, but, in a deviation from the variation margin world, any col- lateral that is pledged to cover these new margin requirements must be segregated at either a tri-party or a third-party custodian account.
“Operationally, firms will also need to establish a mechanism to manage that exposure on a daily basis, so, similar to variation margin, they will need to monitor if it is increasing or decreasing each day, and to have a process to manage the exchange of margin with their counterparties.
“In a further deviation from the cleared world, initial margin requirements are calculated on a non-netted basis, so firms will post IM to their counterparty, but they will also collect it from their counterparty, which is a game-changer.
“Operationally where it becomes difficult is that, today, firms have one margin call for variation margin but, going forward, they may have three margin calls – two for IM and one for VM, thus putting pressure on those firms with legacy processes who lack automation.”
Gemma Bailey, business manager OSTTRA triCalculate, OSTTRA, said the OSTTRA triResolve platform is an important tool for clients. She said: “OSTTRA triResolve is the market leader for portfolio reconciliation and helps to ensure firms are aligned with regards to their key trade economics – an essential step to validate at the start of a firm’s initial margin project. Before you even begin thinking about the calculation of IM, you need to agree both your portfolio and trade economics with each counterparty.
“After calculating AANA and determining that it is highly likely that are in scope for phase six, you need to start thinking about how you are going to calculate initial margin. Whether you expect to post IM or monitor IM, you need a robust way of performing the calculation which will provide transparency on how close you are to internal thresholds, and once you begin exchanging IM, will be robust enough to withstand IM reconciliation disputes.
Bailey added: “OSTTRA triCalculate is the first step in the calculation process. We work with clients to create or use an existing trade file, which will allow us to compute PV sensitivities – these are the input to the SIMM model. Our results file includes sensitivities in the CRIF format; we can then go on to compute IM on an agreement level or pass on those SIMM sensitivities to Acadia’s IM Exposure Manager for reconciliation.”
Murphy said OSTTRA is important to clients because it offers a full suite of margin services: “The key thing is that this is an end-to-end solution. The calculation of IM is the first step, but OSTTRA also supports both the monitoring and margining of IM, IM reconciliation, and, finally, the exchange and settlement of collateral. “The platform is unique as an offering as it is a single service provided by one vendor – unlike other options where a client might take a calculation engine from one vendor, a settlement piece from another vendor and operations engine from a third.
Murphy continued: “We remove any implementation requirements for clients – this is a turnkey delivery, simplifying the onboarding process and removing project risk. Due to being reliant only on a single vendor, no configuration is required.
“Some might say that phase six firms have it easier than those in earlier phases because they can benefit from previous lessons learned. There are also more vendors and consultants that can assist with compliance.
“Unlike firms in phase one, they have a choice of vendor solutions to help them calculate and reconcile IM. Phase 6 firms have a broader range of segregation options and the market is now more familiar with the legal documentation.
“They also benefit from regulatory guidance that allows them to defer some of the preparation steps should their IM exposure remain below €50m – a huge benefit to them and something that wasn’t there in phases one to four.”
Murphy said: “The scope of the project might also be reduced for firms in phase 6 as they may not need to complete some of the steps of preparation ahead of the September 1 deadline.
“The final point is that while regulatory relief is a welcome benefit, it also creates a bit of a quandary because firms don’t know if they are able to take advantage of it. For example, it only allows them to defer steps should their IM exposure remain below €50m. The question is: “How long do you expect to remain below €50m?” So, this requires firms to do some simulation to calculate expected IM and time to breach the threshold. This needs to be done as early as possible – there’s no point doing this in August because, by then, you should have completed the project steps.”
He concluded: “We are working with clients to do those simulations now, and by estimating their IM exposure early, they are able to come up with a better project plan where they can take that fork in the road that says I need to do all the steps, or, I can pause and focus on IM calculation, which is a mandatory requirement anyway.”
Bailey stressed a key difference of the next phase when compared to earlier stages: “One of the things that is different about phase six is that it is the last phase of UMR, therefore if phase six firms have started to adjust strategy and utilise services such as compression and clearing more actively, they may be able to fall under the AANA requirement and out of phase six altogether. Saying this, these clients need to remain mindful of their trade activity from this point onwards, and perform repeat AANA calculations to ensure they won’t be caught in subsequent years.”
Murphy said there is, however, a capacity challenge for the industry at large: “Less of a challenge for firms, but more for the industry, is that phase six is significantly larger than those phases that have gone before. We are talking 600+ firms trying to fit through the door on September 1 which creates potential bottlenecks for market-wide capacity. In-scope firms are all working with the same tri-parties and custodians, similarly they are all calling the same 10 or 12 dealer counterparties to establish documentation, and that is difficult for the market to simultaneously support for so many firms.”
Bailey continued: “In addition, firms need to be in communication with their counterparties on the fact that they are going to be in scope for phase six, and organising timeframes for testing with those counterparties.
She added: “For firms looking to remain under the phase 6 AANA threshold and avoid UMR altogether, as I mentioned before, they need to be completely in touch with their trading activity and routinely monitoring their impact on AANA.”
Bailey concluded: “They will be looking to compression exercises, whether that is a multi-lateral cycle like OSTTRA triReduce, or making bests efforts to compress bilaterally against counterparties with large portfolios. As mentioned before, a strategic move into clearing is another option our client base has been looking into.”