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Navigating UMR with the right partnership

Navigating UMR with the right partnership

The importance of uncleared margin rules (UMR) was brought sharply into view by the collapse of Archegos Capital Management at the end of March, resulting in more than $10 billion in losses at several prime brokers. IHS Markit considers how partnerships with third parties can help buy-side firms in Asia prepare for the new rules

The UMR regime has been rolled out in waves since 2016, but was disrupted by the Covid-19 pandemic last year. Regulators postponed the implementation of phases five and six to September 2021 and 2022, respectively. While Archegos Capital Management would not have been subject to phase five of the UMR, buy-side firms should feel a sense of urgency regarding the upcoming rule changes.

Many institutions still have work to do to comply with the new rules – regardless of which phase they fall under. While some firms have used the delays wisely, others downed tools and deferred taking any action on UMR. Firms that have delayed taking action are inevitably looking at working with external vendors to meet the deadlines, either opting to outsource their entire end-to-end workflow or parts of it. 

Expected challenges for UMR phases five and six

For firms due to fall in-scope, there are relatively few lessons to be learnt from phases one to four. For starters, the volume of in-scope entities will be considerably higher than in the previous waves – phase five contains more firms than phases one to four combined. 

The nature of firms involved also poses a challenge, with non-bank financial institutions now falling in-scope. This has implications in terms of the resources and capabilities available to manage the UMR process, with outsourcing becoming a preferred solution. Mike Duncan, derivatives specialist, investment solutions at insurance group AIA, agrees that outsourcing is the most logical solution for non-financial institutions. He says: “We do not have the resources a bank has. Doing it in-house requires human resources, new technology and workflow changes. For us, it is a matter of ‘Do we want to reinvent the wheel?’ The answer is no.”  

Firms that operate across Asia also face additional hurdles in dealing with the nuances of different jurisdictions. They may find that parts of their business that do not come in-scope still have a direct bearing on the risk the entire group can undertake with counterparties. “This will be a big deal for institutions with a presence in emerging markets who may need to cease business with certain counterparties or severely limit it,” says Duncan. 

Outsourcing versus in-house approach

Most phase five and six firms in Asia are opting to work with external vendors when it comes to UMR implementation. Zaid Shahzadeh, executive director, business development at IHS Markit, comments: “There have been some U-turns among those who initially opted to build internally. After a deep dive into the requirements to build an end-to-end solution to meet the UMR requirements, these firms decided to outsource at least part of their workflow.”

There are three categories of third parties institutions can work with. Vendors able to perform the initial margin (IM) calculations and modelling are particularly in demand in the Asian market as there is a strong presence of complex structured derivatives products. This means it would be a significant undertaking to build standard initial margin model (Simm) methodologies internally from scratch.

Market data is another area where external expertise is invaluable. If the modelling infrastructure is in place, firms still require market data to run the Simm and IM calculations. Added to this is the requirement for historical market data for backtesting purposes. 

Finally, there is a decision to be made on whether to have infrastructure on premise or opt for cloud-based solutions. Firms in Asia shifted to the cloud slowly compared with other regions, but the trend has accelerated during the Covid-19 pandemic as access to offices became more problematic. Shahzadeh says: “We have seen an additional hurdle to outsourcing being removed. That has encouraged more firms to look at outsourcing some or parts of their UMR operations to third parties.”

Opportunity for review of all systems and processes

Firms taking the third-party route will need to consider whether to outsource parts of the workflow or opt for a complete end-to-end solution, where all the necessary calculations and software feed into an ecosystem that requires very little incremental work for the financial institution. There is a preference for the latter approach across Asia, with only institutions that have fewer counterparties opting to take on more aspects in-house.   

While UMR compliance is undeniably complex, there is a sense that firms are using the process to review their entire front-to-back system to determine if they can achieve additional efficiencies. It’s clear that investment in new systems needs to bring long-term gains, yet many firms are finding it to be a worthwhile investment as they benefit from increased flexibility and efficiencies, as well as gain easier access to data that can help guide their investment decisions. 

Subscribe to Fixed Income In-Focus, a bi-monthly commentary series by IHS Markit, analysing trends in the fixed income market. Our analysts leverage data, valuations and modelling capabilities to examine global market developments, translating what this means for Asia-Pacific market participants and how it should influence the way they identify opportunities or mitigate risks.

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