Smartstream Thought Leadership: Trevor

CUSTODY DERIVATIVES ANALYSIS: TREVOR NEGUS, SMARTSTREAM

Smaller firms face decisions in countdown to last round of Uncleared Margin Rules

Trevor Negus, senior product manager, TLM Collateral Management at SmartStream, tells Luke Jeffs about the various options facing firms that need to comply with the last phase of the Uncleared Margin Rules.

The last and most impactful phase of the Uncleared Margin Rules (UMR) takes effect in September and smaller firms coming into scope for the first time need to think now about how they are going to prepare for the regulation.

Similarly, large firms that have already ensured their compliance and that of their large to mid-sized clients are faced with a new set of challenges as the next wave of regulation brings into scope hundreds of smaller firms.

SmartStream has long worked with buy and sell-side firms to help them with various middle and back office functions such as reconciliations but the firm has come to the fore in recent years as UMR has swept across the industry.

SmartStream and its many clients have learned key lessons from the earlier rounds of regulation but the sixth and final round in September does present some new challenges.

Negus said: “There are different pressures depending on what kind of firm you are. If you are a phase six firm coming into scope, then the pressures are different to those of a large bank or broker that’s been in scope for a while but is obviously having to take on these new phase six clients.

“For the phase six firms themselves, they have to prepare in terms of calculating their AANA, determining how they are going to calculate their initial margin, what their custodial arrangements are going to be, the documentation that needs to be put into place and whether they need a collateral system, and what reporting system they put

in place. Now, some or all of this, they may decide to outsource or they may decide to manage that internally, so that is what phase six firms need to be thinking about.”

The top banks and brokers can draw on their experiences from the preceding five rounds of regulation, including the latest wave in September 2021, but this next round represents a ratcheting up of existing requirements.

Negus said: “For the larger firms, it’s mostly a question of increased volumes and costs so they will need to onboard a lot of new agreements, process more margin calls and settlements, and, with that, comes more reporting. With increased volumes, comes increased costs, so they will have more custodial overheads, they will have to source more collateral so the question is how do they solve these greater volumes and greater costs?”

SmartStream thinks that automation based on standardisation is a key theme for all clients.

Negus said: “From my perspective, I think firms should be automating as much as possible, and to achieve automation, they need the building blocks for that, so that is things like standardisation and digitisation as well as adopting standard industry initiatives like ISDA SIMM, the ISDA Common Domain Model and the ISDA Standard Legal Agreement Taxonomy. By adopting standards, it is far easier to automate.”

He added: “The other big building block is connectivity. You need to connect internally with your up and downstream systems for reporting and settlement, for consuming or posting out to your inventory. And there’s external connectivity so connecting up externally to utilities like AcadiaSoft, tri-party custodians or recs engines.”

Different firms face different challenges and are therefore looking for different solutions.

Negus said: “The smaller, phase six firms are looking for a turnkey solution rather than the overhead of installing a large collateral solution and everything that comes with that. What they want is a solution where a lot of the IT overThere are different pressures depending on what kind of firm you are. If you are a phase six firm coming into scope, then the pressures are different to those of a large bank or broker that’s been in scope for a while but is obviously having to take on these new phase six clients.

head is handled externally so, with that in mind, we have a cloud-hosted solution called TLM Collateral that offers considerably lower installed costs.”

He continued: “It comes with business continuity and full production support, while your hardware costs are much reduced though you can pay for what you need when it comes to hardware. You don’t have to buy for the maximum volume you will be processing rather you can upscale and downscale as you need it so it’s much more cost effective.

“As well as that you get auditing, archiving, service level agreement reporting and the test environment. All of that comes with the cloud offering, so all of that makes it much more turnkey for the clients.”

Negus said the SmartStream cloud solution tackles security concerns by sitting in a private cloud which also side-steps performance bottlenecks associated with public clouds.

Negus continued: “Clients can also customise the solution which is important for them should they need to make changes to the workflow or the types of reports they require, and all of that can be done via a private cloud solution.”

Negus said the cloud solution is also interesting to larger firms however. “From a larger firms’ perspective, perhaps they are happy with an on-premise but we see cloud also being important for larger firms. For the larger firms, it’s more a question of connectivity. Because the collateral system is the heart of the middle office ecosystem, it needs to be connected up and that needs to be done through APIs.”

The next and last round of UMR benefits from the experience drawn from earlier rounds but it should not be underestimated. Firms need to engage with partners like SmartStream now to ensure they see no disruption to business as usual in September.

Full interview available to view on digital version of Global Investor at www.globalinvestorgroup.com

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BANKS AND BROKERS

Bank of the Year: BNP Paribas

Client Clearing Provider of the Year: Marex Market-Maker of the Year: Citadel Securities

Non-Bank FCM of the Year: Marex

EXCHANGES AND CLEARING

Best Technology Innovation by an Exchange: B3 – Brazilian Exchange & OTC Clearing House of the Year: LCH Group Exchange of the Year – Europe: Eurex Exchange of the Year - The Americas & Canada: Nodal Exchange Most Innovative Contract of the Year: Eurex

Global Exchange of the Year: Eurex

TECHNOLOGY

Collateral Management Solution of the Year: TriOptima, Part of OSTTRA Connectivity Provider of the Year: Avelacom Derivatives Trading System of the Year: ION Group Equity Trading System of the Year: Itiviti, a Broadridge Business Market Data System of the Year: MayStreet Market Surveillance Solution of the Year: Solidus Labs

Multi-Asset Trading System of the Year: Derivative Path Post-Trade System of the Year: FIS Cleared Derivatives Regulatory Reporting Solution of the Year: Kaizen Reporting Risk Management Solution of the Year: Quantile Trade Reconciliation Solution of the Year: HelloZero

Trading & Execution Solution of the Year: Tradeweb

INDIVIDUAL AWARDS

Lifetime Achievement: Timothy Knight Chief Executive of the Year: Ashish Chauhan, BSE India

TriOptima looks ahead to last phase of UMR

TriOptima, part of OSTTRA, won the Collateral Management Solution category in the FOW International 2021 awards. Speaking in late January 2022, some seven months before the introduction of the sixth phase of the Uncleared Margin Rules in September, Neil Murphy and Gemma Bailey, both business managers at TriOptima, reflect on the challenges posed by the next wave of margin reforms.

Neil Murphy, business manager, TriOptima, OSTTRA, said: “At a high level, the rules effectively introduce a requirement for firms that trade on a bilateral OTC basis to exchange initial margin, effectively moving the bilateral world closer to the cleared space. It’s quite a jump for firms. Those firms that clear today may be familiar with initial margin, albeit using a different model, but, in a deviation from the variation margin world, any collateral that is pledged to cover these new margin requirements must be segregated at either a tri-party or a third-party custodian account.

“Operationally, firms will also need to establish a mechanism to manage that exposure on a daily basis, so, similar to variation margin, they will need to monitor if it is increasing or decreasing each day, and to have a process to manage the exchange of margin with their counterparties.

“In a further deviation from the cleared world, initial margin requirements are calculated on a non-netted basis, so firms will post IM to their counterparty, but they will also collect it from their counterparty, which is a game-changer.

“Operationally where it becomes difficult is that, today, firms have one margin call for variation margin but, going forward, they may have three margin calls - two for IM and one for VM, thus putting pressure on those firms with legacy processes who lack automation.”

Gemma Bailey, business manager, TriOptima, OSTTRA, said the triResolve platform is an important tool for clients.

She said: “triResolve is the market leader for portfolio reconciliation and helps to ensure firms are aligned with regards to their key trade economics - an essential step to validate at the start of a firm’s initial margin project. Before you even begin thinking about the calculation of IM, you need to agree both your portfolio and trade economics with each counterparty.

“After calculating AANA and determining that it is highly likely that are in scope for phase six, you need to start thinking about how you are going to calculate initial margin. Whether you expect to post IM or monitor IM, you need a robust way of performing the calculation which will provide transparency on how close you are to internal thresholds, and once you begin exchanging IM, will be robust enough to withstand IM reconciliation disputes.

Bailey added: “triCalculate is the first step in the calculation process. We work with clients to create or use an existing trade file, which will allow us to compute PV sensitivities - these are the input to the SIMM model. Our results file includes sensitivities in the CRIF format; we can then go on to compute IM on an agreement level or pass on those SIMM sensitivities to Acadia’s IM Exposure Manager for reconciliation.”

Murphy said OSTTRA is important to clients because it offers a full suite of margin services: “The key thing is that this is an end-to-end solution. The calculation of IM is the first step, but TriOptima also supports both the monitoring and margining of IM, IM reconciliation, and, finally, the exchange and settlement of collateral.

“The platform is unique as an offering as it is a single service provided by one vendor - unlike other options where a client might take a calculation engine from one vendor, a settlement piece from another vendor and operations engine from a third.

Murphy continued: “We remove any implementation requirements for clients - this is a turnkey delivery, simplifying the onboarding process and removing project risk. Due to being reliant only on a single vendor, no configuration is required.

Murphy: “Operationally where it becomes difficult is that, today, firms have one margin call for variation margin but, going forward, they may have three margin calls.”

“Some might say that phase six firms have it easier than those in earlier phases because they can benefit from previous lessons learned. There are also more vendors and consultants that can assist with compliance.

“Unlike firms in phase one, they have a choice of vendor solutions to help them calculate and reconcile IM. Phase 6 firms have a broader range of segregation options and the market is now more familiar with the legal documentation.

“They also benefit from regulatory guidance that allows them to defer some of the preparation steps should their IM exposure remain below €50m - a huge benefit to them and something that wasn’t there in phases one to four.”

Murphy said: “The scope of the project might also be reduced for firms in phase 6 as they may not need to complete some of the steps of preparation ahead of the September 1 deadline.

“The final point is that while regulatory relief is a welcome benefit, it also creates a bit of a quandary because firms don’t know if they are able to take advantage of it. For example, it only allows them to defer steps should their IM exposure remain below €50m. The question is: “How long do you expect to remain below €50m?” So, this requires firms to do some simulation to calculate expected IM and time to breach the threshold. This needs to be done as early as possible - there’s no point doing this in August because, by then, you should have completed the project steps.”

He concluded: “We are working with clients to do those simulations now, and by estimating their IM exposure early, they are able to come up with a better project plan where they can take that fork in the road that says I need to do all the steps, or, I can pause and focus on IM calculation, which is a mandatory requirement anyway.”

Bailey stressed a key difference of the next phase when compared to earlier stages: “One of the things that is different about phase six is that it is the last phase of UMR, therefore if phase Bailey: “triResolve is the market leader for portfolio reconciliation and helps to ensure firms are aligned with regards to their key trade economics.”

six firms have started to adjust strategy and utilise services such as compression and clearing more actively, they may be able to fall under the AANA requirement and out of phase six altogether. Saying this, these clients need to remain mindful of their trade activity from this point onwards, and perform repeat AANA calculations to ensure they won’t be caught in subsequent years.”

Murphy said there is, however, a capacity challenge for the industry at large: “Less of a challenge for firms, but more for the industry, is that phase six is significantly larger than those phases that have gone before. We are talking 600+ firms trying to fit through the door on September 1 which creates potential bottlenecks for market-wide capacity. In-scope firms are all working with the same tri-parties and custodians, similarly they are all calling the same 10 or 12 dealer counterparties to establish documentation, and that is difficult for the market to simultaneously support for so many firms.”

Bailey continued: “In addition, firms need to be in communication with their counterparties on the fact that they are going to be in scope for phase six, and organising timeframes for testing with those counterparties.

She added: “For firms looking to remain under the phase 6 AANA threshold and avoid UMR altogether, as I mentioned before, they need to be completely in touch with their trading activity and routinely monitoring their impact on AANA.”

Bailey concluded: “They will be looking to compression exercises, whether that is a multi-lateral cycle like triReduce, or making bests efforts to compress bilaterally against counterparties with large portfolios. As mentioned before, a strategic move into clearing is another option our client base has been looking into.”

For more information regarding our UMR solutions, please email info@trioptima.com. Or visit our website

TriOptima is now part of OSTTRA, a leading provider of progressive post-trade solutions for the global OTC markets.

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