While the compliance deadline for a set of regulations impacting non-cleared derivatives margining known as BCBS 261[1] may have been deferred, it is now approaching at an alarming rate—and is going to have an explosive effect on how non-centrally cleared derivatives are traded and margined. Although the United States regulators (Prudential Regulators, Commodity Futures Trading Commission) have already approved and issued final rules, other jurisdictions are lagging, with Europe only expecting to issue final confirmation of the full scope and requirements this month. For financial firms, the deferment and phased approach has caused uncertainty, raised concerns about meeting the deadline—and added to the pressures to conform on time.
What’s the hurry?
The global regulations apply to all new contracts and trades entered into or opened on or after September 1, 2016; the first wave includes firms that trade upwards of three trillion euros (or equivalent) in non-cleared derivatives. This includes the world’s top 20 to 30 banks who will need to not only mandatorily exchange variation margin (VM), but also gross initial margin (IM)—the latter being a big change for these banks in having to calculate, optimize and post vast amounts of IM securities or cash on a daily basis.
The second wave of regulations, due in September 2017, includes firms trading upwards of 2.25 trillion euros (or equivalent) for IM. Perhaps more significantly the regulations will also require all firms, regardless of the size of their over-the-counter (OTC) trading portfolios, to exchange VM by March 2017. As a result, not only the next tier of banks will be affected, but also buy-side and non-financial firms whose collateral processes are often less established.
As a result firms need to re-engineer their front-to-back OTC derivatives collateral technology and processes. The effects are wide-ranging—from legal agreement repapering, initial margin model approval/build, group-level thresholds, to additional haircuts, strict collateral eligibility rules and settlement and custody requirements.
Enormous complexity lies behind the new global regulations; countries may differ in their interpretation of the rules and, despite the requests of the industry for equivalence across jurisdictions, as it stands any financial firm trading with different countries needs to comply with not only its own regulations, but also those of where its counterparties are based.
Where do the priorities lie?
Several wide-ranging actions need to be considered in meeting the new regulations. A sample of the most challenging ones include:
- Correctly determining the classification of all of one’s own entities and those of counterparties to understand if they are in scope of margin exchange and subject to which jurisdiction’s rules. Despite the efforts of the industry to automate this data-intensive process via a centralized solution such as “ISDA Amend“ there are now doubts this will be ready by September 2016, resulting in banks having to carry out the detailed analysis and exchange of this data on a manual or bilateral basis.
- Documenting new IM CSAs with first wave counterparties and documenting new/amending existing VM CSAs with first wave and second wave counterparties—a massive challenge given the fact that the mechanism to execute the repapering is yet to be finalized by the industry (for example, VM protocol, final regulatory VM/IM CSA templates), vast numbers of bilateral entity permutations in play and lack of skilled in-house resources in the market to undertake this labor-intensive activity in the short space of time available.
- Custodian engagement for IM segregation setup (opening segregated accounts, signing account control agreements, connecting up with them to exchange data and so on)—despite the fact that the industry has been aware of the difficulties of setting up this infrastructure, it is only now that the major Triparty Agents/Custodians are obtaining legal opinions on their proposed account control/collateral transfer agreement documents and working with ISDA to standardize these.
- Assessing organizational readiness (training, resourcing, policy and procedure updates and so on)—this is no mean feat given the regulators require banks to put in place detailed written policies and procedures against which they can conduct their regulatory examinations and therefore banks need to ensure all relevant staff are fully trained on the implications of the regulations on their day-to-day roles and responsibilities
- Deciding on the composition of in-house build efforts versus partnering with any of the emerging industry utility providers— while the benefits of central market-wide solutions is evident, the jury is out in terms of which will be ready by September 2016 and become part of the fabric of the industry.
Another vital aspect of meeting the regulations is the area of testing; a “go live” date for the initial wave of regulations of September 1 means time is scarce. New processes and procedures must be robust, internally and externally, making both internal and industry testing programs essential for successful completion.
Firms need to act now to gain the right balance between tactical solutions that meet compliance deadlines and delivering a flexible, strategic response that secures trading patterns for the long term—or you may find you are faced with a regulatory “time bomb” that does more than “blow the doors off“ the derivatives market.
Interested in this topic? Then contact me Rajesh Sadhwani, for more.
[1] Also known as BCBS/IOSCO, Basel Committee on Banking Supervision, http://www.bis.org/publ/bcbs261.pdf