By Fred Dassori, Chief Product Officer, Acadia
For nearly a decade, the main focus throughout the derivatives industry has been preparing for and ensuring compliance with all six phases of the Uncleared Margin Rules (UMR). Those offering services to streamline the margining process have been at the center of industry initiatives since before Phase 1 of UMR went live in September 2016, providing risk and workflow tools that are now employed by the vast majority of bilateral derivatives users subject to the regulation.
This year brought an industry-wide sigh of relief that there’s no UMR Phase 7 and creates an opportunity for those firms that have their UMR work behind them to turn their attention to projects that had been effectively on hold for the past few years – in some cases now with new perspective gained from the experience of UMR implementation. With the final phases of UMR over the past few years, we saw broad industry acceptance of standardized solutions for risk management. Examples include risk calculation, reconciliation with counterparties, monitoring against thresholds, back-testing and benchmarking, and pre-trade analytics, all of which have begun to shift from siloed, asynchronous functions to centralized processes that are becoming aligned and integrated with margin workflows. And, for those firms that have implemented their UMR solutions, there is now a heightened interest in continuing to extend the functionality of the automated workflows they’ve established.
Some of this coincides with a change that we’ve seen in the market’s approach to risk management, where there has historically been a view that black-box risk and margin methodologies represented a source of competitive advantage. This is unlikely to change entirely, but we expect a more balanced approach to develop, where industry participants acknowledge the trade-offs that result from lack of transparency and lack of standardization, and begin to shift to central, open models in more areas than just initial margin.
Looking slightly more broadly, we’re seeing a couple of trends beginning to take shape just outside most market participants’ field of view:
The first is in optimization, where we see three developments underway. First is expanding buy-side access to initial margin optimization. Currently only a small percentage of the firms posting initial margin are taking advantage of optimization opportunities, but we expect that to begin changing over the next year or so. Second is optimization that factors in more constraints and more targets, for example firm capital, which is available today to a limited degree, but which we see growing increasingly sophisticated and responsive. The third development is increased frequency of optimization, with the existing multi-lateral optimizations which take place only at specified times being supplemented by targeted, on-demand optimizations. Again, this is currently something that a subset of market participants can perform on their own with selected counterparties and without the support of a central infrastructure, but we expect to see that begin to become more “democratized” and centralized in the next couple of years.
The second trend we see is networked agreement data, moving away from a world where agreement terms between trading counterparties are keyed into internal, siloed systems. We know from our clients that inaccuracies in areas like collateral eligibility are driving errors and disputes. The industry recognizes that a shift is needed to an environment in which all involved counterparties have access to bilaterally reconciled representations of their data. Once this is in place, the opportunities to create further efficiencies across the agreement lifecycle become enormous and far easier to realize.
Finally, it’s worth noting that there are still hundreds of firms that were included in the final phase of UMR but remain below the threshold for moving margin and as a result are currently in a monitoring state. We expect many of those firms to breach threshold in the months and years ahead, and for them UMR compliance remains a critical aspect of their “post-UMR” regulatory response, alongside any additional work associated with SA-CCR, FRTB, or xVA.
The completion of UMR is providing many with an opportunity to revisit initiatives that were shelved while the focus was squarely on initial margin. And fortunately, most firms’ UMR implementations took advantage of centralized services that provide a roadmap to creating operational efficiencies both in bilateral margin processes and beyond. We believe that solutions to operational challenges – regulatory-driven or not – in the post-UMR world will be informed by the industry’s response to UMR, and that competitive advantage will accrue to those who take maximum advantage of shared tools, standardized models, while those firms that choose to go it alone with in-house solutions and bespoke vendor systems will struggle to keep up.
