Pandemic volatility – How it is affecting collateral management

Ed Corral, global head of collateral strategy at J.P. Morgan, explores the impact of the delay to uncleared margin rules phases five and six, and how this will play out alongside the delay to the aggregate average notional amount, as well as the extent to which recent volatility in the market caused by the Covid‑19 pandemic will influence firms’ choice of initial margin (IM) models

Ed Corral, global head of collateral strategy at J.P. Morgan, explores the impact of the delay to uncleared margin rules phases five and six, and how this will play out alongside the delay to the aggregate average notional amount, as well as the extent to which recent volatility in the market caused by the Covid‑19 pandemic will influence firms’ choice of initial margin (IM) models

Was the delay to implementation phases five and six of the uncleared margin rules necessary? What impact is it having on firms’ preparations?

Ed Corral, J.P. Morgan

Ed Corral: While our preparations were on track to meet the original deadline, from an industry perspective, the delay was certainly welcome. Considering that the IM calculation and reconciliation processes are brand new for buy-side firms, the additional time granted by the delay will provide an opportunity for them to dig deeper into the nuances of the International Swaps and Derivatives Association’s standard IM model (Simm) versus getting ready for IM (Grid) for specific product types. They can also use this time to refine the workflows built around the reconciliation process and take advantage of the prolonged testing period. All of this should naturally translate into a smoother go-live – especially for phase five firms.

 

The aggregate average notional amount (AANA) calculation window has also been deferred by a year, potentially creating a new bottleneck before the phase five deadline – to what extent is this a missed opportunity?

Ed Corral: Most buy-side firms already have a good understanding of the size of their derivatives books and have already made a preliminary determination on whether they will be in scope for phases five or six. Delaying the AANA calculation window shouldn’t impact participants’ go-live readiness.

 

How is the need to post regulatory IM affecting firms’ trading strategies and product choices? Which instruments are most likely to be pushed into the cleared world as a result of phase five implementation?

Ed Corral: Firms have become even more keenly aware of the ancillary costs associated with the in-scope trades. Commenting on which instruments will be pushed into the cleared world at this juncture would be speculative. However, to the extent possible, participants will hold on to their long‑dated (pre‑regulatory deadline) trades and steer away from any material changes to avoid making legacy trades in scope for segregation of IM and trigger the additional costs.

 

What tactics are firms employing to drive efficiency in exchange threshold monitoring and optimisation? 

Ed Corral: As buy-side participants start to become familiar with Simm and Grid calculation methodologies, margin analytics capabilities are coming to the forefront. The decision around where to put on a new trade – for example, cleared versus bilateral, and which counterparty or central counterparty – will heavily consider the required IM amount. The buy-side’s front office will need the required tools to make the right decision. 

 

To what extent will the recent market volatility influence firms’ choice of IM models? 

Ed Corral: It still depends on the make-up of a particular firm’s portfolio. The heightened volatility has driven a corresponding increase in required margin. This, in turn, has sharpened all firms’ focus on the most efficient model for their portfolio. While Grid does not allow for offsetting risks and is generally regarded as the more conservative methodology, anecdotally, some buy-side firms have made their own independent determination based on the composition of their overall portfolios.

 

How are firms’ approaches to collateral management likely to change in light of recent events?

Ed Corral: Collateral management continues its journey from a back-office function to a value-generating front-office one. Recent events only speed this transition and highlight the importance of effective collateral management from a cost management/avoidance point of view. Further to recent market volatility, a number of previously ‘dormant’ high-threshold credit support annexes have turned active and exchanged margin for the first time. This has increased firms’ overall collateral requirement, thus creating further stress on those firms’ overall liquidity.

^{Ed Corral’s responses are in a personal capacity, and the views expressed herein do not necessarily reflect or represent the views of J.P. Morgan}

 

Initial margin – Special report 2020
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