Crunch Time for Initial Margin: Challenges and Solutions for the Uncleared Margin Rules
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The final phase of initial margin regulation will represent a big bang expansion of the IM regime, and it will take effect less than two years from now — in September 2020.
Key research questions
- What is initial margin regulation?
- What technology challenges does initial margin compliance pose for market participants?
- What should firms do to support the transition to and maintenance of initial margin operations?
Initial margin (IM) requirements are a global regulatory regime intended to limit systemic contagion by offsetting losses if an OTC derivatives counterparty defaults. IM has significant implications for market participants’ risk and collateral management operations, as well as their technology systems.
Celent, in a report sponsored by IHS Markit, examines the historical background to initial margin regulation and presents an overview of the requirements for in-scope firms and phases and in-scope instruments. The study discusses the considerable challenges of achieving compliance with IM regulation for both sell side and buy side participants, looks at the technology challenges, and suggests approaches to overcoming these challenges, including the use of third party solutions, services, and utilities. The report concludes with recommendations for firms to help support the transition to and maintenance of initial margin operations.
Initial margin requirements are a global regulatory regime that applies to all market participants whose outstanding notional exposure in OTC derivatives exceeds specified amounts. Under the regulations, in-scope firms are required to:
- Establish agreements with counterparties governing their exchange of initial margin.
- Set up segregated custodial accounts for both counterparties to hold collateral posted to meet initial margin requirements.
- Calculate initial margin amounts according to approved models.
- Post (and/or receive) these amounts as collateral to the segregated accounts.
While these requirements seem straightforward enough, every link in the initial margin value chain has significant implications for market participants’ collateral management operations and technology systems. Furthermore, while 2018 marked the chronological halfway point of the IM regulatory rollout, the next two years may see a more than 10-fold increase in the number of firms subject to the regulation.
In short, it’s crunch time for IM.
“Initial margin represents a seismic shift in collateral management operations; firms regularly describe the challenge as ‘immense.’ The smaller market participants that will come into scope in 2019 and 2020 will also face challenges as they attempt to comply with the same rules that have been required of the largest firms. These smaller participants will be challenged in terms of expertise, bandwidth, and budgets,” says Neil Katkov, PhD, author of the report.
“Industry advocates have called for various forms of relief to reduce the burden placed on firms by initial margin regulation. While some measure of relief may be warranted, a surer path to successful IM implementation is automation, STP, and digitized documentation, supported by technology and platform partners,” he adds.