Avoid the rush – Don't let UMR implementation for phase 6 catch you off-guard
The phase 6 implementation of Uncleared Margin Rules (UMR) will mark the broadest test of firms' preparation on Initial Margin (IM) calculation workflows, impacting an estimated 700 firms. But with the September 2022 implementation deadline just months away, firms have relatively little time left to finish their preparations.
Fortunately, phase 6 firms can learn several key lessons from their predecessors' implementation efforts.
Start early
With a large number of firms impacted in phase 6 and a finite number of service providers who can accurately calculate such instruments, it stands to reason that SIMM calculation vendors may not be able to accommodate every firm on time, especially if too many start the process too late.
In phase 5, we saw several firms that underestimated the time and complexity of UMR implementation, which resulted in a rush as the deadline approached and 11th-hour changes that spurred consternation among both firms and vendors. From this, we learned that firms that start as soon as possible stand the best chance of avoiding last-minute headaches.
However, launching the process by a certain date doesn't guarantee that you'll finish on time. There are several facets to address in UMR implementation, some of which can take far longer than many might anticipate. It's just as important — if not even more so — to understand how much time each element of the process can take.
Set-up is only half the battle
Establishing the workflows to produce the calculations you need is only one part of the implementation process. Some of the most intensive work comes afterward, when you then have to test to ensure that those calculations are valid, and, in some jurisdictions, gain regulators' approval to implement them. In our experience, firms tend to underestimate how long these parts of the process can take, and so they don't leave enough time in their planning process to address them.
To test calculations, firms typically need a benchmark number from their counterparties to compare against, or a test portfolio that your service provider will check to validate. If there are differences, you need to dig in to find what's causing the issue. Testing also serves as a way for firms to fully understand the calculations their vendor is providing. Regardless of whether the calculation was outsourced, regulators hold the firms themselves responsible for having a sufficient understanding of the calculation process, as well as a sufficient risk governance framework in place to check whether or not the process is working.
In some jurisdictions, firms also must formally validate the models they use, regardless of whether they were developed in-house or by a service provider. From our experience, this validation process, and the subsequent approval process, can take far longer than most anticipate.
Importantly, firms cannot implement their SIMM solution without getting the green light from regulators, and regulators need time to conduct a proper evaluation. Some firms in phase 5, in fact, had to shift temporarily to the scheduled-based method instead of SIMM because they had not garnered regulatory approval in time.
Avoid a portfolio-vendor mismatch
Many phase 5 and phase 6 firms leverage external resources to manage their margin calculation work, and some may assume that one of their existing service providers will be able to handle their SIMM calculation requirements on their behalf. However, this assumption may not be true. In at least one instance, a phase 5 firm had to scramble for a solution very late in the process after learning that its collateral management service provider could not handle the size or complexity of the portfolio.
Confirming early on whether your service providers have the technology, expertise, and capacity to manage SIMM calculations for your portfolio is key.
- Can they create calculation models for all of the positions you hold?
- Can they perform the calculations on time on a daily basis?
Getting portfolio-specific answers to these questions is important, as some instruments are far more complex than others. Exotic products and those with complex payoffs are notoriously difficult to calculate correctly and require a high level of expertise. Even equity swaps can require complicated calculations if the underlying assets are non-standard or illiquid.
Laying the groundwork
With less than a year before the phase 6 deadline, firms should start laying the groundwork now to understand the full scope of what UMR implementation will mean for them specifically.
- Take stock of the instruments in your portfolio and ascertain their complexity.
- Identify all of the intermediary steps involved in UMR implementation, including testing, validation, and regulatory approvals.
- Create generous estimates for the time, effort, and coordination each step will take.
With this foundational knowledge, you can create a realistic timeline that reflects the size and complexity of your portfolio, identifies the partners needed to complete the process, and accounts for potential issues along the way. By doing so, you can ensure that UMR implementation doesn't catch you by surprise or cause a last-minute rush.
To learn more about UMR implementation and how IHS Markit can help, visit our Initial Margin Calculation Workflow page.
S&P Global provides industry-leading data, software and technology platforms and managed services to tackle some of the most difficult challenges in financial markets. We help our customers better understand complicated markets, reduce risk, operate more efficiently and comply with financial regulation.
This article was published by S&P Global Market Intelligence and not by S&P Global Ratings, which is a separately managed division of S&P Global.