According to the International Swaps and Derivatives Association (ISDA), approximately 1,100 buy-side entities will feel the impact of Phases 5 and 6 of Uncleared Margin Requirements (UMR). This is just the tip of the iceberg, as 9,000 separate counterparty relationships will also be brought into scope. For market participants grappling with UMR, there are significant operational and technical challenges that stand between the firm and seamless compliance.
Many institutions are now facing the unpleasant reality that they do not have the technology to effectively manage margin requirements globally and are now turning to external vendors for help. Until now, financial institutions have been focused on meeting timelines, but within six months of the regulation being live, that’s where the data management challenge comes into play.
Firms scheduled to come into the fold in Phases 5 and 6 must now jumpstart their decision-making processes to identify and implement the proper technology required.
There are five main challenges for buy-side participants and other in-scope financial institutions for UMR in September 2021 and 2022.
1. Complex In-Scope Assessment Process
As thresholds for adherence with UMR decrease throughout the phases, more and more counterparties come into scope. These new in-scope counterparties in Phases 5 and 6 have considerably less resources and knowledge than the interdealer market that was involved in the earlier phases. For firms with a high volume of counterparties, this challenge will be magnified even more.
2. Fragmented Operational and Technology Infrastructures
The increase of UMR counterparties will require a front-to-back review of the existing infrastructure to accommodate an uptick in the volume and complexity of business-as-usual processing. Industry-wide preparation is required for review of custodian arrangements, opening of new accounts, satisfying AML and KYC, accounts segregation, defining eligible collateral and setting up connectivity. A substantial hike in margin call volumes could overwhelm the current operational processes and system infrastructures within banks.
3. Overwhelming Costs to Manage
UMR implementation comes with initial set-up and ongoing costs, in addition to the new margin costs. This could make maintaining Over the Counter (OTC) derivatives positions expensive with increased funding costs and bigger cash balances to meet expected margin calls. For buy-side firms, the challenge is compounded as these costs are likely to make bilateral derivatives extremely expensive, further eating into trading margins.
4. Data and Documentation Requirements
While fulfilling the data requirements for the Initial Margin calculation can be demanding, the greater challenge lies around the volume of onboarding paperwork involved in the client and investor onboarding process. Buy-side firms continue to be overwhelmed with competing priorities as UMR requires firms to thoroughly examine all existing paperwork and gather and extract data from new documents.
The competing priorities can overwhelm firms because of highly complex documentation requirements between their legal, counterparty legal, and internal teams. As different counterparties may be subject to different regulations, the process of gathering and managing documentation remains a huge challenge that will be unsurmountable without an effective data management strategy in place.
5. Cross-Border Impact and Equivalency Challenges
For several businesses, the unique distinctions between global and local regulations will add to the difficulty of adapting to new rules. Regulatory differences between jurisdictions in scope and the applicability of the new requirements creates a huge compliance and operations increasingly challenging. It is critical that counterparties consider, understand, and align to the various rules and requirements issued by various jurisdictions.
Where do we go from here?
For firms to effectively operationalize UMR, it is critical to consider automated solutions that can streamline the in-scope assessment process and address the vast data and documentation requirements. To avoid a regulatory bottleneck, technology is key to enable firms to gain a single source of truth for counterparties and be ahead of the curve in the event of any further changes to the requirements.
The ultimate goal for many buy-side institutions has consistently been greater self-sufficiency, faster more efficient integrations with screening providers, and to reduce friction across the board. It’s up to each institution to develop their own plan of attack, not just with regard to UMR compliance, but for becoming more agile overall to adapt to future change and better serve customers.
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