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The phase 6 implementation of Uncleared Margin Rules (UMR) will
mark the broadest test of firms' preparation on Initial Margin (IM)
calculation workflows, impacting an estimated 700 firms. But with
the September 2022 implementation deadline just months away, firms
have relatively little time left to finish their preparations.
Fortunately, phase 6 firms can learn several key lessons from
their predecessors' implementation efforts.
Start early
With a large number of firms impacted in phase 6 and a finite
number of service providers who can accurately calculate such
instruments, it stands to reason that SIMM calculation vendors may
not be able to accommodate every firm on time, especially if too
many start the process too late.
In phase 5, we saw several firms that underestimated the time
and complexity of UMR implementation, which resulted in a rush as
the deadline approached and 11th-hour changes that spurred
consternation among both firms and vendors. From this, we learned
that firms that start as soon as possible stand the best chance of
avoiding last-minute headaches.
However, launching the process by a certain
date doesn't guarantee that you'll finish on time. There are
several facets to address in UMR implementation, some of which can
take far longer than many might anticipate. It's just as important
— if not even more so — to understand how much time each
element of the process can take.
Set-up is only half the battle
Establishing the workflows to produce the calculations you need
is only one part of the implementation process. Some of the most
intensive work comes afterward, when you then have to test to
ensure that those calculations are valid, and, in some
jurisdictions, gain regulators' approval to implement them. In our
experience, firms tend to underestimate how long these parts of the
process can take, and so they don't leave enough time in their
planning process to address them.
To test calculations, firms typically need a benchmark number
from their counterparties to compare against, or a test portfolio
that your service provider will check to validate. If there are
differences, you need to dig in to find what's causing the issue.
Testing also serves as a way for firms to fully understand the
calculations their vendor is providing. Regardless of whether the
calculation was outsourced, regulators hold the firms themselves
responsible for having a sufficient understanding of the
calculation process, as well as a sufficient risk governance
framework in place to check whether or not the process is
working.
In some jurisdictions, firms also must formally validate the
models they use, regardless of whether they were developed in-house
or by a service provider. From our experience, this validation
process, and the subsequent approval process, can take far longer
than most anticipate.
Importantly, firms cannot implement their SIMM solution without
getting the green light from regulators, and regulators need time
to conduct a proper evaluation. Some firms in phase 5, in fact, had
to shift temporarily to the scheduled-based method instead of SIMM
because they had not garnered regulatory approval in time.
Avoid a portfolio-vendor mismatch
Many phase 5 and phase 6 firms leverage external resources to
manage their margin calculation work, and some may assume that one
of their existing service providers will be able to handle their
SIMM calculation requirements on their behalf. However, this
assumption may not be true. In at least one instance, a phase 5
firm had to scramble for a solution very late in the process after
learning that its collateral management service provider could not
handle the size or complexity of the portfolio.
Confirming early on whether your service providers have the
technology, expertise, and capacity to manage SIMM calculations for
your portfolio is key.
Can they create calculation models for all of the positions you
hold?
Can they perform the calculations on time on a daily
basis?
Getting portfolio-specific answers to these questions is
important, as some instruments are far more complex than others.
Exotic products and those with complex payoffs are notoriously
difficult to calculate correctly and require a high level of
expertise. Even equity swaps can require complicated calculations
if the underlying assets are non-standard or illiquid.
Laying the groundwork
With less than a year before the phase 6 deadline, firms should
start laying the groundwork now to understand the full scope of
what UMR implementation will mean for them specifically.
Take stock of the instruments in your portfolio and ascertain
their complexity.
Identify all of the intermediary steps involved in UMR
implementation, including testing, validation, and regulatory
approvals.
Create generous estimates for the time, effort, and
coordination each step will take.
With this foundational knowledge, you can create a realistic
timeline that reflects the size and complexity of your portfolio,
identifies the partners needed to complete the process, and
accounts for potential issues along the way. By doing so, you can
ensure that UMR implementation doesn't catch you by surprise or
cause a last-minute rush.
Posted 10 January 2022 by Hiroshi Tanase, Executive Director, Product Analysis and Design, S&P Global Market Intelligence
IHS Markit provides industry-leading data, software and technology platforms and managed services to tackle some of the most difficult challenges in financial markets. We help our customers better understand complicated markets, reduce risk, operate more efficiently and comply with financial regulation.
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May 12
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