As the world's largest banks raced to comply with new margin rules for non-cleared derivatives trades in the middle of 2016, one law firm played an instrumental role in helping the industry over the line.
The contribution made by the derivatives and structured finance group at Allen & Overy (A&O) was twofold. Collaborating with a group of dealers, the firm helped to establish documentation templates to facilitate compliance with the initial margin (IM) rules that took effect on September 1. In addition, the firm developed a way to automate the drafting of legal documents at scale; an approach that should help as the industry hurtles towards the much larger variation margining (VM) deadline in March.
"I think the standout contribution from A&O last year was on the non-cleared margin implementation," says Shalini Sharma, a director and senior legal counsel at RBS Corporate and Institutional Banking in London. "They have brought firms together, taken a pragmatic approach to rules interpretation and tailoring their support to the market as a whole, and have kept themselves at the keen edge of all developments."
Concerns about the September deadline began to grow in early 2016. Despite a regulatory postponement that pushed the start date back from December 2015, the industry was facing a struggle to be ready on time – partly because some of the national rules on which documentation would need to be based were still being finalised. "It was the big issue of the summer," recalls David Wakeling, a partner at Allen & Overy. "We were brought in because of concerns the industry was not going to get over the line. What would have happened without our intervention I do not know, but that was our reason for being there."
The firm convened a working group of all dealers subject to the September deadline, called the Phase 1 Dealer Group, which met for the first time in March 2016. The aim was to work through the documents and agree on how their templates should look. Forging agreement on these matters up front would thus make matters more straightforward once the actual negotiations began.
In cases where differences could not be resolved expediently, A&O encouraged the dealers to agree to very uniform provisions. A tool the firm refers to as its 'commercial elections tracker' was developed. A&O drafted 30 provisions on a spreadsheet that could be turned on or off, according to preferences, and circulated it to the dealers.
After each bank had made its submissions, the declarations were passed around the group. Wakeling says this approach cut potentially months off the negotiations and, as a result, most major banks were able to begin exchanging IM in accordance with the rules on September 1, although a backlog in opening custodial accounts meant not all of the banks' in-scope legal entities were initially able to trade with each other.
That was just the first phase of the new regime, catching 21 dealers. Almost immediately, attention turned to the March VM deadline, which applies to all in-scope participants, including hedge funds, life insurers, regional banks and big corporate end-users. With new collateral agreements, known as credit-support annexes (CSAs), required for each counterparty, an unprecedented repapering exercise is on the cards.
The MarginMatrix solution developed by A&O in collaboration with Deloitte is supposed to address the challenge presented by the VM deadline, offering a multi-jurisdictional tool for banks to produce the draft standardised documentation required. In theory, it allows the industry to handle negotiations at scale – and at a far cheaper unit cost. As it currently stands, eight dealers are using the solution across various regulatory regimes.
Early on, A&O understood the solution would need to be flexible, not least because of the indeterminate nature of the final regulation at the beginning of the development process. Users therefore have several options once they have supplied the requisite counterparty information to A&O to be imported into MarginMatrix. On the one hand, the tool supports users who want to use the Variation Margin Protocol developed by the International Swaps and Derivatives Association. Alternatively, it can also be used by banks looking to conduct full bilateral negotiations with their counterparties.
"We built the system to be all things to all people in terms of outreach strategy," Wakeling says. "The negotiation with the counterparty can be done using the Isda protocol – that is one option. Alternatively, users can choose to create a new CSA, amend an old CSA or clone and amend an old CSA via our system."
Perhaps the most remarkable aspect of the project is that it was undertaken on the firm's own initiative, says Wakeling. For the first few months at least, time and money would be invested in the development of a product for which there was no established demand.
"I think that is unheard of actually," he says. "It wasn't a response to clients coming to us and telling us they had a specific problem. We saw the problem coming and set about thinking what we could do to help our clients overcome it."
A&O's lawyers were also kept busy in a variety of other ways during 2016. For instance, the firm advised Napier Park on the creation of a ground-breaking multi-manager origination platform to provide capital to service collateralised loan obligations by acting as risk retention originator, or providing retention financing or warehouse debt or equity. Other key transactional work by the firm includes: advising on hedging aspects of non-dilutive convertible bonds for, among others, National Grid, Vodafone and Total and advising the Isda credit determinations committee on issues surrounding Puerto Rico's credit event.
The week on Risk.net, December 2–8, 2017Receive this by email