Projections have shown that in September 2020, the number of OTC market participants subject to the stringent initial margin (IM) regulatory requirements will explode from a few dozen to thousands of entities. The significant increase in covered entities will be caused by the average aggregate notional threshold being lowered from $750 billion in 2019 to $8 billion in 2020. Compared to the March 2017 variation margin (VM) requirements industry-wide adoption, complying to IM rules after this change will be much more complex.
The need for bespoke, bilateral uncleared contracts continues to be a significant revenue generator. Non-financial end users such as corporations require customized deals to hedge particular risks related to their respective industries and supply chains. The same need applies to “buy-side” financial end users, such as institutional investors and hedge funds, to tailor to their specific investment strategy, hedging certain risks while gaining exposure in a given asset class.
Make Plans Now to be Ready and Compliant
Firms that will be subject to IM requirements in 2020 should make plans now to adapt their business practices and support capabilities in the area of legal documentation, trade pricing and risk, as well as collateral management. This readiness strategy also applies for large financial institutions facing small to medium sized market participants as their ability to scale will determine their capacity to sustain their OTC business.
To begin with, the legal documentation (credit support annex, eligible collateral schedule, account control agreement) should be kept as standard as possible, utilizing an online negotiation documentation and workflow tool. ISDA and fintech firms have started building such software for release in early 2019.
Second, leveraging the Standard Initial Margin Model will be paramount to optimize IM amounts. Existing and upcoming third-party software or cloud-based services should be considered to lower operational costs. Global financial institutions, already subject to IM rules, are currently considering offering an IM “calculation agent” service for their counterparties, although legal challenges remain.
And lastly, IM requires custodian documentation and onboarding for both parties. Furthermore, IM necessitates sourcing non-cash collateral products such as treasuries, corporate bonds, and the ongoing support of collateral movement and disputes throughout a large network of custodians.
Why Monticello
Monticello Consulting Group (MCG) assists clients across the financial services industry in implementing the necessary infrastructure to ensure compliance and reduce regulatory risks. This experience, coupled with our in-depth knowledge of the financial regulatory environment, uniquely positions MCG to guide financial institutions, regardless of their size, in the adoption of OTC swaps margin rules.