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Regulatory relief, but the pressure is still on

Initial margin: Regulatory relief, but the pressure is still on

As the new compliance schedule for IM requirements on non-cleared derivatives comes into force, IHS Markit’s director, derivatives data and valuation services, Kashyap Sheth outlines what to expect next

Given the complexity and costs involved in meeting IM requirements, it’s not surprising the industry’s lobbying drive succeeded in postponing the implementation of the rules for firms with an average aggregate notional amount (AANA) of non-cleared derivatives below certain thresholds. 

Under the revised schedule approved by the Basel Committee on Banking Supervision and the International Organization of Securities Commissions, phase-four firms with an AANA of non-cleared derivatives above $750 billion remain in scope as of September 2019 – while phase‑five firms have been further classified into two distinct segments. As per the changes, phase five will apply to firms with an AANA threshold of $50 billion in September 2020, and firms with an AANA of $8 billion–50 billion are part of a new phase six, which will be effective from September 2021. 

Now this regulatory overhang has been lifted, the pressure is on firms to step up their preparations. 

Understandably, phase‑six firms are happy with this grace period, as they will have more time to evaluate systems and establish new custodian relationships. However, phase‑five firms must now act to prepare for IM requirements. 


Learning from the delay

The debate around the deadline extension has shown that it may have been unrealistic to expect that smaller buy-side firms would be able or willing to allocate a portion of their scarce resources to non-commercial tasks such as IM calculations. After all, many asset managers still rely on spreadsheets to assess collateral requirements, generate valuations and negotiate with counterparties. 

Some buy-side firms have asked their sell-side partners to perform IM calculations for them, but this approach comes with substantial risks beyond conflicts of interest. Few banks are willing to incur the extra liability and additional workload – especially as it involves managing different methodologies across counterparties. Even if a bank were to perform IM calculations for a buy-side firm, the firm would still need to periodically validate these calculations, while responsibility for backtesting the model would need to be addressed. 

Firms unable to invest in building up their IM capabilities should consider outsourcing this responsibility to an independent third party such as IHS Markit. By doing so, they can rely on a best-in-class solution to create efficiencies across the IM workflow, from monitoring to pre-trade analytics, calculations and backtesting. This will also ensure their best interests are being carefully considered.


Breaching the threshold

Phase‑five and phase‑six firms with calculated IM amounts below the $50 million threshold face a significant regulatory overhang. As their IM exposure grows, they will need to know where they stand. IHS Markit understands that firms are concerned about breaching the $50 million threshold. To ensure they can continue trading without interruption, it introduced an IM monitoring service.

This service – which doubles as best practice for funds that have not yet breached the $50 million threshold – can also be provided on a one-off basis to assist with regulatory compliance. It’s configurable at the fund and counterparty levels and can run at various frequencies and threshold levels. Once a firm reaches the threshold, it can seamlessly migrate to our full IM calculation service.

In addition to delivering accurate IM calculations across asset classes, the threshold monitoring results deliver deep insights into how each asset class contributes to the overall IM exposure of clients, enabling a better understanding of IM‑related risk. As the service is fully hosted, it is an efficient, convenient and cost-effective solution for clients.


The emergence of specialised services?

IHS Markit is confident a progressive need for specialised services will emerge. It is unavoidable, given the diversity of its client base, which ranges from large global banks to niche hedge fund managers. The breadth of IHS Markit’s data, cutting-edge technology and deep functional expertise means it is uniquely positioned to leverage its existing capabilities to create off-the-shelf solutions that work for different clients.

For example, not all managers need to deploy IHS Markit’s standard International Swaps and Derivatives Association standard initial margin model (Simm) calculation, including risk sensitivities. However, some may prefer to receive risk sensitivities exclusively. Given the range of potential use cases, IHS Markit’s specialised services are flexible to the unique needs of clients, including their preferred approach for delivery.

Another case in point is the new IHS Markit Simm Backtesting Service, which can help satisfy regulatory requirements in multiple jurisdictions. For smaller firms, developing an in-house backtesting solution is cost-prohibitive, so IHS Markit developed a specialised service that integrates its computational power, simulation capabilities and historical market data to help clients compare and validate their IM in a fully hosted environment.

Understandably, there are many other scenarios in which IHS Markit can help firms comply with IM requirements. Heading into phases five and six, IHS Markit remains in close collaboration with clients and partners to ensure its services continue evolving in step with global requirements. 

IHS Markit welcomes the opportunity to discuss how it can be of service to your firm.


Initial margin – Special report 2019
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