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July 13, 2015

Margining rules: is time still of essence?

The topic of margining implementation timetable had received much coverage in the media and generated passionate debate within the industry. ISDA had been advocating for a delay of two years from the point final national rules are published before the requirements become effective. The hopes for a significant postponement were quashed after the CFTC chairman predicted it to be “just a matter of months”1. At the end, the opinions seem to have settled in the middle.

Margining rules: is time still of essence?

by Silvia Devulder

The topic of margining implementation timetable had received much coverage in the media and generated passionate debate within the industry. ISDA had been advocating for a delay of two years from the point final national rules are published before the requirements become effective. The hopes for a significant postponement were quashed after the CFTC chairman predicted it to be “just a matter of months”1. At the end, the opinions seem to have settled in the middle.

On 18th March 2015, the BCBS-IOSCO announced the much expected delay to the implementation of requirements to exchange both initial margin (IM) and variation margin (VM). The VM requirements were phased in, with gradual implementation first for large dealers in September 2016 followed by the rest of the “covered entities” in March 2017. The IM phase-in period has moved forward to 2016 – 2020, based on the same trading volumes criteria.

Time to sit back and relax now?

As a result, the majority of the derivative counterparties have 2 years from now to implement the new rules. This does not mean that we should slow down the implementation efforts. The challenges as we are preparing for the implementation of the requirements remain the same: re-documentation based on new industry standards, operational changes driven by the new collateral architecture, ability to capture and consume new data and methodologies to be set up for computing phase-in and other collateral amounts are only examples. However, the revised dates give the firms just enough breathing space to develop, implement and test new systems.

What is the next step?

The BCBS-IOSCO proposal still remains to be implemented at the national level. In the EU, the ESAs are expected to publish a second consultation paper on the margining of non-cleared derivatives in the coming weeks2, aligned with the new international timelines. The industry expects a short consultation period, focused on the questions raised in the first round.

According to its 2015 Regulatory Work Program, ESMA expects the European margining regulatory standards to be finalized by September/October 20153. 2015 Q3 timeline is also mentioned in the ISDA compliance calendar4. The publication of final rules however does not necessarily mean the crystal clear clarity on what exactly is expected from the industry. There will be interpretation issues; ESMA ́s EMIR Q&A may provide some useful guidance. Moreover, translating the legal clauses into a concrete action plan at each entity level will be a hard nut to crack. ISDA, assisted by its members, stands behind to help the industry with this uneasy task. One of the working group ́s deliverables is an implementation tool listing the process changes needed from operations, technology and business perspective: “Minimum Considerations for Uncleared Margin-Future State Workflow (MCD 2.0)” is now ready in the ISDA bookstore5.

Many still underestimate the scale of changes needed. There are many reasons to start preparing for the new margining regime. Although there are outstanding points, there is a lot you can initiate already now.

Delay or not to delay? 5 reasons to start now.

Many were relieved when BCBS-IOSCO announced postponement of the margining timeline for non-cleared OTC derivatives6. Unfortunately, such well-intended breathing space may have unintended consequences. As we all know, the financial industry thinks in short term. The P&L considerations do not incentivize to see beyond the end of the financial year. How many derivative players were stricken with the idea to postpone the started margining implementation or at least deprioritize the projects budget-wise?

Of course, it is not always good to be the first or even early in the process. Errors are easily made in an untested environment. Implementation in absence of final rules poses challenges. Exploring potential solutions is more costly and time consuming while wait- ing may reduce the budget in a short run and allow focusing your energy elsewhere.

In this case however, a forward looking approach could be a winner providing that you have competence, vision and ability to adjust the investments and strategy decisions as you move along with the industry.

1.The new timeline is just what you need.

Two years from now might sound a long way off, but the new requirements are complex and their implementation time consuming. ISDA and the industry requested a delay to allow “timely” implementation (and did not get as long as they lobbied for7). The concern was that the markets will not be able to comply otherwise. This is therefore not a “postponement” but the new realistic deadline assuming that the work is pursued as planned.

2.Keeping up with the industry is worth the effort. Early implementation creates new business opportunities.

To keep following the industry developments in the real time allows choosing the most efficient internal solution based on the new industry standards as they emerge. Dropping out may disqualify your firm from the precious brainstorming with the industry at the development stage and compromise your chances to anticipate the future needs.

On the sell-side, anticipating the market infrastructure changes often means a better service and innovative solutions for the clients. The increased regulatory costs associated with trading derivatives will force the buy-side to rethink the way it trades derivatives, makes use of collateral assets and allocates resources. Both sides may gain the momentum and opportunity to stand out among the competitors if they can adjust before the new rules kick-in.

3.Make the best of the lessons learned so far and build on it without a break.

Expecting the December 2015 deadline, you may have been working intensively to analyze the rules and boil them down to the concrete implementation tasks. The interruption risks breaking the momentum and watering down the intelligence you have gathered. Considering the complexity of the task, the compliance dates are not that far away. Do not throw away the lessons learned to resume the process all over again just in a few months.

4.Do not underestimate the scale of changes needed.

The margin requirements implementation poses significant challenges. This is obvious to the firms required to start collateralizing their non-cleared derivatives portfolio for the first time. However, even the entities used to receive the margin calls under the old regime will have to undergo significant changes. It is not just a matter of bringing the “thresholds” and “minimum transfer amounts” in the ISDA Credit Support Annexes in line with the regulatory maximums. We will have to rethink the internal processes, systems, infrastructure, policies and the way we use collateral. The newly released ISDA Minimum Consideration Document (MCD v 2.0) shows just how complex the exercise may be (depending on the existing internal set up of each player). For example, the identified areas of impact range from counterparty set-up/on-boarding, through front office trading systems, collateral management/margin messaging platforms, exposure calculators, collateral eligibility, haircut calculators. And much more follows when the IM comes to the picture. In short, the new rules are more complex than you may expect. Do not let them get you by surprise.

5.Anticipate the re-documentation workload.

You can launch the re-documentation process only at the final stage when the industry standards, implementation tools and new compliant internal policies are set. However, understanding the new documentary infrastructure and broad lines of the upcoming legal terms is key to assess your workload and plan ahead. You and your counterparties will appreciate early heads-up in the new documentary landscape. Having a re-documentation plan early is reassuring and essential to ensure continuity of the trading relationship. If you are however late at the compliance dates, you will have to stop trading until the documentation is in place (which may have long term effects to the interrupted business relationship).

Footnotes

1 According to The Financial Times, 11th March 2015
2 Not yet released when this article was drafted
3 See fields 187/188 re clearing and margining rules: http://www.esma.europa.eu/system/files/2015-277_rev1_-_esma_2015_regulatory_work_programme.pdf
4 http://www2.isda.org/attachment/NzM1MA==/OTCd%20Compliance%20Calendar%202015-4-01.pdf
5 http://www2.isda.org/functional-areas/wgmr-implementation/
6 VM compliance date phased-in between September 2016 and March 2017 and IM phased-in between September 2016 and 2020 depending on trading volumes of each counterparty at the group level.
7 two years from the point final national rules are published before the requirements become effective
8 http://www.esma.europa.eu/page/OTC-derivatives-and-clearing-obligation 9 http://www2.isda.org/functional-areas/wgmr-implementation/


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