March 8, 2017
Hooray for global relief to the uncleared margin rules! As is typical with such things, the industry is grateful for some relief to one of the largest changes to the derivatives markets. But it is unfortunate that such relief has come only at the last moment. Now that the pressure is temporarily off, where does the market stand? Is the extra time to comply with the rules a good thing? With all market participants lifting their foot off of the accelerator, new challenges will present themselves over the next six months.
As a reminder, the framework for the uncleared margin rules was developed in 2009 by global authorities and framed in such a way that most derivative trades must be collateralized at the mark-to-market amount called “variation margin” or “VM”, with a phase in over time of even more collateral, a buffer on top of the variation margin referred to as “initial margin” or “IM”. Over the past two years, the regional regulators developed and finalized their rules setting in motion all of the work that market participants must do to comply with the rules.
The first major test to implement the uncleared margin rules came in September of 2016 when most global banks found themselves having to comply with the rules for trades among themselves. Many expected bottlenecks ensued. Some were expected and discussed here. Others caught industry veterans by surprise, such as the amount of incorrect data in bank systems, operational hiccups in implementing the new regime, internal stakeholders, such as risk and treasury departments, that wanted to be inserted into part of the process, and the high level of coordination among all of the dealers and the independent third party custodian banks who hold the IM collateral exchanged by the global banks. With resources scarce, documentation teams were stretched to their breaking point and the custodian banks were initially unable to keep up with the new volume of accounts being opened. Downstream bank teams were also stretched as they took the new data from their freshly executed documentation and fed it into new systems to handle the new collateral exchanges.
With so many hiccups in September of 2016, it should come as no surprise that regulators have postponed adherence to the March 1, 2017 deadline for VM compliance with the scope of the work stretching out to the great majority of market participants. After all, if industry veterans working within the major global banks had so many issues in September 2016, then how will so many banks and their clients cope with the March 1, 2017 deadline?
The March 1st relief came with some guidance from various regulators, including IOSCO and the U.S. prudential regulators, although much of the explanation lacks clarity and defined actions or steps to be taken. One is left wondering if legal bills will now increase in order to be assured that the banks and market participants are taking the proper action during their relief period? Should banks take their foot off of the accelerator when there is uncertainty as to the relief?
Many in the industry expected to be compliant to the VM rules by March 1st with the remainder of March used to reconcile files, update bank systems, shut down non-compliant accounts, and other administrative tasks. Instead we find the industry past the March deadline with only a small percentage of the world’s documentation complying with the uncleared margin rules. Many in the industry hired third party vendors to assist them to meet the March deadline so what happens now with the vendor relationships past the original deadline? Did the vendor do their part to meet the March deadline? Market participants who used a vendor should consider a number of factors again to decide what their next steps are not only during this relief period but also as IM gets rolled out more broadly over the next three years.