OTC margins: The challenges of regulatory compliance
Even by the standards of today’s fast-changing regulatory environment, the new OTC variation margin requirements due to be introduced from March 2017 pose a major challenge to sell-side and buy-side alike. Asset managers will face major operational burdens and risks as they prepare to comply; the scale of which may not yet be fully appreciated.
By some estimates, the number of variation margin calls will rise by up to five to 10 times, with the potential for the current fail rate — estimated at around 3% — to increase significantly.
Some asset managers have as many as 1,000 funds, with several dealer counterparties per fund. They will each have to pledge variation margin on a daily basis, as well as many posting initial margin, leading to large volumes of reporting and settlement.
There are a number of software vendors and solution providers poised to support asset managers through this transition. The sooner that asset managers start to think about the technology systems and operational process they will need in place, the better. Earlier planning will mean that they will be able to take a strategic view and explore how they may leverage the change, not only to comply with regulations, but also to optimise their collateral management.And they may also want to optimise the collateral they hold while complying with more stringent segregation requirements in many instances.
Varying levels of preparedness
Last year, a survey of the level of preparedness of derivatives market participants found that most still had a lot to do. Published in May 2015, and produced by Aité Group, Collateral Management in Europe: Searching for Central Intelligence highlighted the substantial need for internal investment in collateral management, as well as a drive for capital market infrastructure improvements and expectations for future services from market infrastructure providers.
In general, it found firms looking for greater standardisation of messaging and a shift away from the current norm of email-based, manual interactions. Some 25% of respondent firms highlighted a lack of standards as a key challenge to effectively managing collateral, while another 20% identified a lack of automation as a major pain point.
The paper also showed buy-side firms in general to be less prepared than the sell-side, although this might be expected given that brokers face an earlier compliance deadline of September 2016. More than half of buy-side firms, for example, had not felt any need to optimise collateral and felt no need to do so in future.
Benefits of global market infrastructure
Working closely with asset managers and their custodians, DTCC-Euroclear GlobalCollateral Limited, a joint-venture between Depository Trust & Clearing Corporation (DTCC) and Euroclear, has identified a number of areas where its global infrastructure can help the buy-side prepare, introducing the automation and collateral optimisation that asset managers are likely to find essential.
But collateral is going to be a scarce resource, and when it comes to collateral optimisation, GlobalCollateral will enable asset managers to mobilise the right assets at the right time and at the right place, to allocate it across counterparties.Following the receipt of an agreed margin call, GlobalCollateral enriches the message to include appropriate standing settlement instructions. Using straight through processing, it then automatically sends a settlement message to the right party — custodian, administrator or broker-dealer. Enriching the message helps to minimise failed trades while automation means that custodians receive messages earlier in the daily processing cycle. Consolidated reporting and record-keeping link settlement activity to margin activity, providing a high level of transparency.
Finding practical solutions
Asset managers must not delay their preparations and need to begin to analyse how the non-cleared margin requirements will affect them. Even after all the different accounts, technologies and counterparties are considered, the task of preparing can be complex, and the risks and the costs significant.
Understanding the nature of the challenge is key: for some larger asset managers it will require a transformational change in operations. This may well involve rethinking relationships, as well as working in close collaboration with counterparties, custodians and infrastructure providers. The sooner they begin to address the challenge, the better equipped they will be to take a strategic approach.
By Ted Leveroni, Chief Commercial Officer, DTCC-Euroclear GlobalCollateral Ltd.
For more information about DTCC-Euroclear GlobalCollateral Ltd, visit: www.globalcollateral.net.
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