On 3 Aril 2020, the Basel Committee on Banking Supervision (BCBS) and the International Organization of Securities Commissions (IOSCO) announced deferral of final implementation phases of the margin requirements for non-centrally cleared derivatives.

Statement by BCBS:
"In light of the significant challenges posed by Covid-19, including the displacement of staff and the need for firms to focus resources on managing risks associated with current market volatility, the Committee and IOSCO have agreed to extend the deadline for completing the final two implementation phases of the margin requirements for non-centrally cleared derivatives, by one year."

A view from the Euroclear Collateral Conference

While Phases 1 to 4 of the Uncleared Margin Rules (UMR) went relatively smoothly, with a limited number of sellside firms impacted, Phases 5 and 6 may be more challenging and very different in a number of ways - not least the scale, the complexity, the learning curve, and the cultural changes that will be necessary for the successful rollout. 

And despite having many years of anticipation, market participants say that preparations are only now underway. Phases 5 and 6 will be nothing less than a sprint to the finishing line.

As opposed to Phases 1 to 4, Phases 5 and 6 will involve the buyside. Many asset managers’ funds and separate accounts, pension funds and insurance companies are scheduled to come in-scope of UMR based on their notional thresholds either with Phase 5 on 1 September 2020 or with Phase 6 on 1 September 2021.

The buyside is a much more fragmented area than the sell side. “Phases 5 and 6 will be very different from Phases 1 to 4,” says Amy Caruso, Head of Collateral Initiatives at ISDA. According to Caruso, ISDA’s data estimates that between them Phases 5 and 6 will cover some 1100 entities, 315 in Phase 5 and 775 in Phase 6. And between these entities there will be some 9,000 separate counterparty relationships, 3,600 covered under Phase 5 and an additional 5,400 coming in-scope in Phase 6. The sheer scale of this extension is daunting, and quite different from the numbers involved in the first four phases. “The numbers involved are quite staggering,” says Jane Karczewski Managing Director and Head of Global Custody at HSBC.

"Phases 5 and 6 will be very different from Phases 1 to 4"


Adding to the numerical challenge, is the fact that for many of these entities, the intricacies of the regulation will be new to them. “The first four phases were complicated but the wealth of different client types in Phases 5 and 6 means this will be a huge challenge,” says Karczewski. “Counterparties who are not used to doing this are now having to figure it out.”

This is a steep learning curve for many on the buyside and there is a sense that preparations are only just getting going. Bankers report that the engagement on Phase 5 is now ramping up, even though the clock is ticking to the September 2020 deadline.

Models, collateral and documents

There are three areas where market participants say that action needs to be taken and taken quickly. First, they need to decide which segregation model is most appropriate. Secondly, but undertaken at the same time as the segregation model analysis, is a deeper understanding of the collateral drag that will impact returns. And finally, there is the challenge of documentation and systems implementation.

The segregation model discussion is vital, because unlike Phases 1 to 4, a triparty solution is not necessarily the best for all types of buyside entities. “This is a complex new infrastructure and lots of decisions need to be taken in a very short period of time,” says Alex Dockx, Executive Director, Securities Services at J.P. Morgan. “The first four phases were between banks and broker dealers… but Phases 5 and 6 involve new counterparties, who, in particular, are not used to triparty.”

Finding the right segregation model will be a challenge and different segregation models will appeal to different entities. One option that is proving popular is the pledge account at Euroclear Bank which is already well-established. It allows the buyside to keep their existing custodian but with an extra layer on top, which allows for segregation.

"This is a complex new infrastructure and lots of decisions need to be taken in a very short period of time"


For an asset manager or other institutional investor, posting securities held in portfolios as collateral for hedging or other market activity is both complicated and costly. “The buyside does not have a box of excess securities that they can just use as collateral,” says John Straley, Executive Director at DTCC. “They will have to manage it on a day to day basis.”

Taking securities out of portfolios, to use as collateral, will by necessity reduce the ability of those securities to deliver performance to the portfolios. It will also impact liquidity in those portfolios, at a time when liquidity concerns in the buyside are heightened. This will focus attention on which collateral is eligible, how it could cause a performance drag and how it also drains liquidity as more HQLA become locked up. This could cause a backlash.

It will also become a cultural challenge for some buyside entities, especially those larger institutional investors who have not traditionally used securities as collateral. “There is a big cultural difference for the Asian buyside, for instance, who are used to only using cash as collateral,” says HSBC’s Karczewski.

The buyside need to take on board the fact that, as has happened in the sellside, collateral optimisation will become a key, strategic area of focus for their entire business. Collateral efficiency will become a key differentiator and will make a meaningful difference to performance. It will become a key focus area of the front office.

Having decided on the model and understood the performance impacts of collateral, asset managers need to get going on the documentation and the systems roll out. Both are time consuming and intense. Alongside the documentation are the IT systems which underpin all financial transactions. And these take as long to set up as the documents do to get agreed. “These IT systems need to be set up now,” says Caruso at ISDA. “You cannot sit back and just wait for September 2020. It will be too late by then.”

Phase 5 and 6 of UMR present huge challenges. Phases 1 to 4 showed that these are not insurmountable, but the numbers involved, the shortened time frame, the decisions that need to be made and the documentation that needs to be completed suggest it will be far more complex than what happened before.

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