Avoid the rush: don’t let UMR implementation for phase six catch you off–guard

With firms soon to be subjected to phase six of the uncleared margin rules (UMR), the implementation of phase five has taught a series of valuable lessons. Firms must grasp the complexity of the processes and ensure they are prepared in time for implementation, which is just months away. Hiroshi Tanase, executive director of product analysis and design at S&P Global Market Intelligence, offers his insight into how firms can avoid being caught like a deer in the headlights

Hiroshi Tanase, S&P Global Market Intelligence

The phase six implementation of UMR will mark the broadest test of firms’ preparation processes on initial margin (IM) calculation workflows, impacting an estimated 700 firms. But, with the implementation deadline of September 2022 looming, firms have relatively little time left to finish their preparations.

Fortunately, phase six firms can learn several key lessons from the implementation efforts of their predecessors.

Start early

With a large number of firms impacted in phase six, and a finite number of service providers that can accurately calculate such instruments, it stands to reason that standard initial margin model (Simm) calculation vendors may not be able to accommodate every firm on time, especially if too many start the process too late.

In phase five, 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 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 foresee. It’s just as important – if not even more so – to understand how much time each element of the process can take.

Setting 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 after, when you must test to ensure those calculations are valid and, in some jurisdictions, gain regulators’ approval to implement them. In the experience of S&P Global Market Intelligence, 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 a service provider will check to validate. If there are differences, firms 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 must also formally validate the models they use, regardless of whether they were developed in-house or by a service provider. In 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 five, in fact, had to shift temporarily to the schedule-based method instead of Simm because they hadn’t garnered regulatory approval in time.

Avoid a portfolio-vendor mismatch

Many phase five and six firms leverage external resources to manage their margin calculations, 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 five firm had to scramble for a solution very late in the process after learning 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 payouts 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 until the phase six 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 co-ordination 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.

 

Initial margin – Special report 2022
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