The Final Countdown to Phase 6 of UMR
July 27, 2022
Read Time: 4 minutes
Regulation
Himanshu Bagri
Rahul Bighane Product Manager, Product Management
Ram ChidambaramSenior Vice President, Product Management
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Uncleared Margin Rules (UMR) first came into effect in 2016. In the first four phases, only a small number of firms that held significant swap exposures were affected. However, with Phase 5 that started in September 2021 and the final Phase 6 slated to begin in September 2022, hundreds of new firms are in scope for this Basel III global framework that aims to reduce the risk of derivatives exposures.
For many, preparing for UMR is a resource-intensive undertaking. As we discussed in our 2020 whitepaper, firms need to plan well in advance to ensure they can adapt their technology and operational processes. With Phase 6 only months away, engaging the right technology partner can help ensure readiness for UMR compliance and significantly transform a firm’s broader margin and collateral management process.
The average aggregate notional amount (AANA) for firms in scope will be $8 billion – a threshold that will bring many buy-side firms under UMR’s scope. The AANA calculation determines whether an entity falls under the mandate and must be calculated separately for each entity per jurisdictional rules. Given the complexity of bilaterally traded exotic derivatives and the need to produce the calculation on demand, the AANA calculation becomes one of the primary challenges funds need to solve.
Firms must also address complex data attributes, including risk sensitivities required to calculate initial margin (IM) under the standard initial margin model (SIMM). Given the proprietary nature of risk models and sensitivities, maintaining control over data is a major concern. The flexibility to maintain full oversight for how data is sourced and shared with counterparties and vendor systems will also help deliver improvements beyond the IM process.
Firms not only need sophisticated master data management capabilities, they must also have access to a comprehensive data model to store and manage complex data attributes. Market data adapters and robust ingestion abilities can provide flexibility in sourcing risk sensitivities and other attributes from data vendors and files.
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Firms in scope for UMR can calculate IM using either the grid-based or risk-based SIMM model. For firms trading swaps, UMR requires an independent internal view of IM. Preparing for this calculation before the regulatory deadline helps in-scope firms make informed choices while negotiating new credit support annexes (CSA) with counterparties.
As in-scope firms prepare for UMR, they should examine the detailed breakdown of the SIMM calculation to understand the risk distribution of portfolios and ensure complete confidence while issuing and disputing IM calls. A licensed ISDA SIMM vendor can offer the expertise firms need.
The support of an experienced partner can also be useful when it comes to legacy swaps, which are defined as swap positions opened under existing house margin arrangements with counterparties before UMR takes effect. While the exception for legacy swaps will, in some cases, allow for a lower capital requirement, it also introduces additional operational complexity in dealing with two types of margin – house margin for the legacy swaps and regulatory margin for the other swaps. Firms need to weigh the margin benefits against the operational costs in deciding how to treat legacy swaps. Making the analysis even more complex, certain lifecycle events, such as conversions or novations, could bring legacy swaps in scope for IM, effectively erasing the benefits of treating them differently.
When UMR takes effect, firms will also need to independently issue IM calls to their counterparties. Tools to validate incoming IM calls and credibly dispute anomalies are essential to helping make informed decisions about IM methodology and optimal portfolio allocations.
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Calculating the SIMM is just one complexity of UMR. Firms must also consider both regulatory margin per the SIMM calculation and margin calculated per ‘house’ rules, ultimately determining the applicable IM based on the methodology defined in their CSA. An integrated view of variation margin, regulatory, house, and applicable IM on a single interface will help in-scope firms manage their complex workflow.
Collateral management workflows have become increasingly complicated since UMR mandated a two-way collateral movement through non-cash assets for regulatory IM. Impacted firms must manage the intricacies of collateral schedules, haircuts, asset selection, substitution, and optimization. Therefore, a simple approach to managing these requirements is critical.
To overcome the numerous challenges UMR introduces, firms need a sound operational process reinforced by sophisticated technology and experienced professionals.
With Arcesium’s Treasury Suite, we arm our clients with comprehensive margin and collateral management tools. Clients can further augment these capabilities with our Financial Operations professionals to confidently navigate UMR compliance.
Our Treasury Suite helps our clients understand eligibility, offers built-in tools to calculate IM, and supports clients in streamlining their margin management process. Since the inception of Stage 5, our margin and collateral management analysts have successfully issued and disputed IM calls across our clients’ swaps agreements. So far in 2022, our clients have saved millions of dollars of margin collateral through successful disputes.
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