Volatility and extra time – A double-edged sword

Amid Covid-19 lockdowns, sports fans have been finding alternative ways to satisfy their craving for competition, whether virtual horse racing driven by data algorithms, repeat broadcasts of Olympic nostalgia or the opportunity for football supporters to have their cardboard cutout images grace stadium terraces across Europe, where remaining matches will be played out behind closed doors.

Similarly, buy-side firms in advanced preparations for phases five and six of initial margin (IM) rules are eager to maintain momentum and put those efforts to the test now that implementation has been delayed by 12 months following disruptions related to the Covid‑19 pandemic.

One option is a virtual run of IM processes from the original deadline of September this year. AcadiaSoft plans to facilitate such demand with a soft launch of services on September 1, allowing phase five firms to run IM calculation and reconciliation virtually, before critical documentation such as credit support annexes and account control agreements are even in place. This kind of simulation could provide crucial insight into changing collateral requirements, which skyrocketed amid recent volatility.

Total margin call amounts on over-the-counter derivatives more than trebled in March to $5.56 trillion, according to AcadiaSoft data, forcing firms without large liquidity pools to source additional collateral from the market just to scrape over the line. Many phase five and six firms are worried those pain points will be magnified once new IM call and funding requirements are added to the mix.

“Volatility has exposed any existing weaknesses in collateral systems, processes and organisational setup,” says Chris Watts, director and co-founder of Margin Tonic. “Ongoing volatility is now a more realistic prospect and those phase five and six firms burned by the recent volatility are now either looking – or should be looking – at the additional year they’ve been given and thinking how they can leverage their IM delivery to future-proof their collateral infrastructure.”

He hopes the combination of extra time and increased volatility will drive a more strategic long-term view of margin strategy at buy-side firms, rather than the band-aid fixes many were relying on simply to drag themselves over the compliance finish line.

For a large portion of the estimated 900 firms set to be caught in phases five and six of the IM regime, the latest postponement is a welcome reprieve. But for some it’s a growing frustration.

Some dealers decry what they see as excessive delays, saying it’s ‘business as usual’, despite widespread remote working. “The vast majority are repapering, some full-steam ahead, some taking their time,” says a margin official at a European house.

Implementation has suffered multiple setbacks, with an additional sixth wave added to the planned five-phase schedule and a further 12-month extension for the final two phases – double the six-month delay some felt was sufficient for phase five only. An influential Commodity Futures Trading Commission committee is now pushing for a further six-month compliance grace period. This means phase six firms with aggregate average notional amounts of derivatives between €8 billion and €50 billion might not be caught in the net until March 2023 – two and a half years beyond the original timeline many had been working towards.

“If firms were looking at this in early 2019 and are now looking at possible 2023 implementation, they could have had a project going for four or five years. It sounds crazy they could have invested that amount of time, resource and budget to meet those regulations,” says a margin expert. “People understand why phase five was split and no one could have seen Covid coming, but another six months on top? It feels unnecessary.”

Initial margin – Special report 2020
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