The final phases of the BCBS / IOSCO’s uncleared margin rules — phase 4 and 5 — are kicking in as from 1 September 2019 and 2020. Ready or not, initial margin requirements are coming. And unless you’re compliant in time, you won’t be able to trade bilaterally.
In the final instalment of our series, we look at how to minimise the additional Initial Margin you are required to post and what technology tools you need to implement ISDA SIMM whilst trading cost-effectively.
Part 3 of 3: Minimise the impact of ISDA SIMM.
It is one thing to focus on meeting the regulatory requirements for implementing UMR and SIMM in your collateral management process with all the complexity and resource-intensive steps that brings.
But it is also critical that you focus on how the new collateral requirements impact your liquidity and P&L, and ways that impact can be mitigated
Looking at the big picture of how SIMM impacts your firm, the key challenge is:
How to bring transparency and analytics on Initial Margin into the trading lifecycle, so as to minimise impact on liquidity and portfolio performance.
The key factors here are:
- Consider SIMM IM impact at all stages of the trade life-cycle.
- Implement a front to back technology solution, not just end of day flows.
Impact of additional Collateral Needs
ISDA note in their July 2018 discussion paper, that UMR’s phases 4 & 5 will result in greater demand for collateral and increased margin call activity. This will likely affect your liquidity, create funding challenges and, potentially impact your overall fund performance. The fundamental objective of all stakeholders is to reduce the impact of the additional margin requirements by managing trading decisions, actively monitoring portfolios, and dynamically reducing counterparty exposure.
This can be summarised as:
Predict (Manage capital and ensure Best Execution)
The best time to manage initial margin impact is before the trade is executed. Your pre-trade decision making should include an understanding of margin impact and deriving the cost of collateral that truly reflects the performance impact and opportunity cost to your firm.
Specifically for bilateral trades, your SIMM solution should integrate into your portfolio modelling and trade execution workflows so that you estimate SIMM before going to market for execution quotes, and allow you to determine the overall best price.
Proving best execution
With MIFID II now in force, best execution rules have become tougher. It’s no longer a case of taking ‘all reasonable steps’ to achieve the best possible result. You must now take ‘all sufficient steps’.
Thus integrating your SIMM calculation into your pre-trade workflow becomes even more crucial. Not only does it better manage your risks but it also provides tangible proof of compliance with MIFID II best execution requirements.
Track (Monitoring and Attribution)
When separate portfolios have trades booked against the same counterparts, under the same agreements, there can be unintended consequences when adding new trades or, more importantly, unwinding positions.
It is important to monitor your overall IM exposure during the day to highlight potential collateral and funding impact due to pricing or trading activity.
A SIMM IM solution provides recalculation during the day and provides alerts of movements to manage the collateral impact ahead of time. For that matter, a firm should aim to have a solution that covers all asset classes, including cleared OTC and ETDs.
Another key component to track SIMM impact is attribution of IM usage (and therefore capital usage) to individual trades, strategies or portfolios. This allows both clear identification of the trades and strategies that are driving the IM usage but also where future trade unwinds could cause IM spikes.
Reduce (Optimise and mitigate margin)
To reduce the impact of SIMM you need to reduce the overall margin requirement itself, at both pre and post-trade times:
- At pre-trade time– as discussed above, trade against the counterpart where the biggest overall portfolio offset can be achieved.
- At post-trade time – novate legacy trades into a SIMM agreement where they provide margin offset with new trades.
Looking at trade novation opportunities can cover different approaches including:
i) Identifying legacy trades that provide offset benefit by moving under a SIMM based agreement
ii) Identifying potential for novating trades between counterparts to create risk offset and reduce SIMM IM
The right technology – Front to back
It is clear that firms need to not only calculate and process initial margin in their collateral management process, but also monitor, and minimise IM throughout the day.
So any technology solution needs to be determined using a front to back lens.
A SIMM, and general IM, solution can be implemented in house (costly) or sourced from an external provider like Cassini. Whichever approach is taken, these are some key features that your solution must provide:
- Run scenario tests
- Apply sophisticated limits
- Automate margin optimisation models (e.g. novation or compression)
Intra-day & High performance
- Ability to deploy on premises if required
- Ability to scale to minimise calculation times
- Ability to test SIMM and IM
- Link to intra-day monitoring
Flexibility of Curves, Models, and Data
- Integrate with in-house or sourced market data
- Ability to modify curve models to match internal and counterparty pricing
- An open API allows easy integration with your current workflows
Of course, Cassini provides all the tools to help you achieve best execution, minimise capital impact, and integrate to your collateral management workflow. Our solution is either AWS hosted or locally deployed.