Go live or not?
That was the question on the minds of roughly 20 major over-the-counter (OTC) derivative counterparties in the days leading up to September 1, 2016. That’s when the first phase of the BCBS-IOSCO uncleared margin rules was set to take effect in the United States, Canada and Japan. For more information on the regulation, read my previous blog on the topic.
On the evening of the deadline, the US Commodity Futures Trading Commission (CFTC) issued time-limited, no-action relief on the collateral segregation requirement for initial margin (IM), citing custodial documentation unpreparedness. Those who had been working around the clock to appropriately margin all OTC derivative trades covered under the new regime breathed a collective sigh of relief.
But the feeling was short-lived. As it turned out, the one-month relief period came with conditions that most covered swap entities couldn’t meet. So, when the Asian markets opened, the rollout continued in full swing.
Operational impacts
The final framework of minimum standards published by the BCBS-IOSCO Working Group on Margining Requirements in September 2013 posed a number of challenges:
- Publication of the final rules in each jurisdiction was delayed
- The operational interpretation was unclear
- There was a lack of rule harmonization across jurisdictions
- The custodian requirements were continually evolving
- Until as recently as this past August, it wasn’t clear whether the Standard Initial Margin Model (SIMM), the IM calculation methodology, would be approved
All of this uncertainty further squeezed the already-tight timeline for industry testing and documentation.
Many organizations have adopted a semi-manual support model, resulting in a level of exception management that is unsustainable for operations departments in the longer-term. Connectivity issues with industry utilities and custodians, combined with unresolved documentation and know-your-client (KYC) requirements, have also prevented certain entities from entering into desired OTC derivative contracts.
Commercial impacts
Implementing uncleared margin rules in only three jurisdictions was never going to be a commercially popular decision among derivative counterparties.
On the eve of the go-live date, CFTC Commissioner Giancarlo expressed his astonishment regarding the “blindness to commercial reality,” going on to state that: “The decision ensures that overseas competitors will profit handsomely to the tune of likely tens of billions of dollars in new customer business taken from American firms.” [1]
Unsurprisingly, trading volumes dipped significantly across regions on September 1, with many trading partners unsure whether certain entities were compliant and ready to trade.
Two key challenges ahead
As rollout ramps up and expands to other jurisdictions in the coming months (see timeline below), Accenture will be monitoring two key things:
- Harmonization: The CFTC declared equivalence with the JFSA’s rules—inter-affiliate margining excepted—eight days after the September 1 go-live date. As other jurisdictions come on board—including the European Union, Switzerland, Hong Kong, Singapore, India and Australia—the hope is that they too will aspire to rule harmonization.
- Process automation: As volumes ramp up and margining thresholds are breached, any deficiencies in the straight-through processing (STP) of margin and outstanding onboarding items will need to be remediated quickly. A swift transition away from manual processing will be critical.
Implementation timeline for uncleared margin rules [2]
- September 2013: The BCBS-IOSCO Working Group on Margin Requirements publishes its final framework of minimum standards.
- October 2015: US prudential regulators (PRs) publish final rules.
- December 2015: The US Commodity and Futures Trading Commission (CFTC) publishes final rules.
- March 2016: The Japan Financial Services Agency (JFSA) publishes final rules.
- September 2016: Initial margin and variation margin (IM/VM) requirements come into effect for covered entities whose aggregate a month-end average notional amount of non-centrally cleared derivatives exceeds $3 trillion (or equivalent in other jurisdictions)
- End of January 2017: The uncleared margin rules are expected to go live in Europe at the end of January next year. As it stands the European Commission is widely expected to finalize the regulatory technical standards (RTS) in October this year after which the RTS will move to the European Parliament and the EU Council and be published in the Official Journal of the EU, as long as there are no objections. Finally the RTS would enter into force after 20 days and take effect one month after that—this would equate to a date of in or around the end of the third week of January 2017
- March 2017: Variation margin requirements roll out for all covered entities.
We’re following this rollout closely—and I’m sure you are too. If you’re interested in discussing the implications for your organization, you can reach me at rajesh.sadhwani@accenture.com.
Acknowledgments: With thanks to Petra Yazbeck (Capital Markets Consultant) for her contributions to this blog
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[1] http://www.cftc.gov/PressRoom/SpeechesTestimony/giancarlostatement083116