Engagement Summary
The Fall of 2020 saw Monticello called in to support a leading bank’s Regulatory Cross GBAM Initiatives team implement a newly introduced U.S. Securities and Exchange Commission (“SEC”) regulation for Uncleared Security-Based Swaps (“SBS”) and Security-Based Swap Dealers (“SBSDs”) with a Nov ember 1st, 2021 compliance date. As part of G20 reforms to the OTC (over-the-counter) derivatives market, national regulators implemented rules requiring the exchange of margin for all derivatives not cleared through a central counterparty. While the CFTC (Commodity Futures Trading Commission) completed its rulemaking and implementation process a number of years ago, the SEC only recently fully finalized its ruleset. The directive for participants in a previously opaque swap market was to increase transparency, and the various actions to achieve that directive include, but are not limited to, the following client documentation requirements
1) Information Exchange
Security-based swap dealers (SBSDs) can exchange a new ISDA-produced U.S. Self-Disclosure Letter, amongst other related disclosures, with clients in order to understand whether the regulation’s rules apply to their relationship. Furthermore, SBSDs have some disclosing to do on their end. SBSDs, for example, are required to stress their clients’ right to segregate the initial margin for the Uncleared SBS transactions. These are clear examples of the SEC’s efforts to increase transparency in the swap market.
2) ISDA SBS Protocol Adherence
ISDA Protocols have been adding immense value to the industry for decades and the SBS Protocols are the latest installment in their efforts to eliminate the necessity for costly and time-consuming bilateral negotiations. As part of the SEC implementation, ISDA launched the SBS Protocol which is intended to be completed by parties who have not entered into the earlier Dodd-Frank protocols ISDA launched in August 2012 and March 2013. The SBS Protocol enables parties to efficiently amend and/or supplement their trading documentation by incorporating relevant portions of the new SBS rules and regulations
As part of the CFTC implementation, ISDA launched two protocols in August 2012 and March 2013. If a client had adhered to those earlier protocols, their terms were included in their ISDA Master Agreement. The Top-Up Protocol amends the ISDA Master to address regulatory and documentation requirements applicable to SBSDs relating to SBS transactions, allowing terms previously included in the CFTC Protocols for CFTC compliance to be “topped up” for SEC compliance
3) SBS Margin Adherence
These new regulations have their sights set on uncleared SBS trades and ensuring that a mandatory requirement for the exchange of margin is now imposed. In a nutshell, clients must collect IM from an SBS counterparty when breaching the $50 million dollars initial margin threshold and must also exchange VM. As previously mentioned, the CFTC published an analogous regulation many years prior, yet this SEC regulation has a number of nuances that have not only resulted in ISDA providing brand new margin documentation[1] but have market participants exploring the applicability of “substituted compliance.” This mechanism, which became affectionately known as “sub-camp” within the industry is discussed later in this case study and was integral to the evolution of this regulation and how t impacted Day 1 requirements for SBSDs and SBS counterparties.
Monticello deployed experts from its Change Management and Financial Services practice areas to project manage four of the program’s seven individual workstreams. Monticello’s proven track record in this space resulted in the client equipping Monticello’s team with the authority to centrally manage the governance structure across program workstreams and to effectively hold stakeholders accountable. Given the public nature of SEC Regulations, compounded by the change at the helm of the securities watchdog midway through the program[2], there was heavy scrutiny on program health from senior management up to the Board and C-suite executives. Being in a position to implement a clear communication strategy, which resulted in sound risks and issues management, was intrinsic to maintaining program momentum towards the timely completion of the SEC’s regulatory requirements and satisfying the added senior stakeholder scrutiny.
Case Study Detail
PROJECT BACKGROUND
A brief history on the authority of the CFTC versus the SEC and how that feeds into traditional swaps versus SBS adds some much-needed context to why this regulation has only just been introduced. 2010 saw the declaration of President Obama’s Dodd-Frank Wall Street Reform and Consumer Protection Act, with the CFTC being one of the various regulators tasked with embedding the Act’s rules into the financial services industry. Title VII of the Act focused on swap and derivatives regulation. The CFTC, generally charged with regulating swaps, began to accordingly impose their regulations soon after 2021 but the SEC, generally charged with regulating security-based swaps, have only just begun to impose theirs. The SEC broadly defines “security-based swaps” as swaps based on (1) single security or (2) a loan or (3) a narrow-based group or index of securities or (4) events relating to a single issuer or issuers of securities in a narrow-based security index.[3] Accurately identifying which of our client’s traded products fit these definitions formed the backdrop to the rest of the SEC SBS Program, which was focused on adherence to the rules enabling compliant trading of these products post-November 1st, 2021.
ENGAGEMENT OBJECTIVES
Program Management & Governance
Implemented a project management structure to facilitate effective communication across what were very interdependent program workstreams. Monticello established weekly workstream-specific governance routines within each of its workstreams that seamlessly bubbled up to monthly Executive Council meetings, ensuring senior stakeholders were provided with the most accurate and up-to-date program health updates. The program was educated to consider Executive Council forums as an opportunity to not only keep senior stakeholders engaged but to have decisions and proposals formally approved to remove any obstacles that stood in the way of project momentum. Some more specific examples of workstream program management and governance included:
Gathering and defining business requirements in bi-weekly sessions, throughout the program's planning phase, that encouraged active stakeholder participation across the Business, Operations, Legal, Compliance, and Technology. These collaborative sessions focused on mapping the requirements of the rule to tangible business outcomes and, in turn, mapping these outcomes to technological enhancement to the client's trading systems that would facilitate the uninterrupted and compliant booking of SBS trades once the rule took effect.
Supporting release management including end-to-end go-live planning, testing, and execution, with the aid of experts from Monticello's testing governance capability.
However, paramount to the success of all program management and governance is the manner in which one chooses to communicate with stakeholders. The chosen communication methodology can make or break a program’s ability to meet its objectives
Stakeholder Communication & Reporting
Leveraged a strategic communication structure to provide tailored updates to stakeholders at varying levels of seniority and accountability for program deliverables. Material program updates were communicated through a weekly 4-blocker that highlighted program status, key accomplishments, upcoming milestones, the path to green plans, and key risks, issues, and dependencies. As Monticello resources began to build relationships with various stakeholders, communication styles were tailored to ensure both the client and Monticello worked together in the most productive manner.
SUBSTITUTED COMPLIANCE AND NO-ACTION RELIEF
Firms looking to establish substituted compliance were largely successful in their applications to the SEC, with the SEC’s final publications of sub-camp orders slightly moving the goalposts for such firms. Our client was one of those firms. Taking a step back, the SEC defines substituted compliance as a “mechanism that allows the Commission to determine that certain participants in U.S. security-based swap markets may satisfy certain requirements under the Securities Exchange Act of 1934 (“Exchange Act”) and the rules and regulations thereunder by complying with comparable non-U.S. requirements.”[4]Our client’s two European entities benefitted from substituted compliance granted in the spring and summer for the UK[5] and France[6], respectively, in which it was accepted that these entities had complied with foreign requirements that the Commission had found to be comparable. This relieved a significant amount of pressure on margin and capital requirements, particularly in terms of complex and time-consuming margin IM and VM CSA documentation that would otherwise have had to be negotiated with clients by November 1, 2021. Unsurprisingly, there were a number of conditions attached to the 200+ page orders that our Monticello Teams pored through with a fine-tooth comb to understand the margin requirements that endured but the fact remained that the documentation burden was reduced. Furthermore, the SEC granted a request from ISDA and SIFMA to issue no-action relief for SBSDs, articulating the fact that they do not need to collect initial margin from certain counterparties in connection with an uncleared SBS until September 1, 2022. This 11-month relief from the initial compliance date for such margin requirements was a welcome respite for not only our client but the swap market writ large.
BUSINESS VALUE
Monticello Consulting Group provides services across the financial services industry to ensure compliance and reduce regulatory risks. By working with clients to successfully translate complex regulatory requirements into effective business solutions, Monticello enables clients to implement the necessary risk and control framework to ensure industry challenges are turned into opportunities. Our team partners with cross-organizational client teams and oversees the end-to-end execution of regulatory compliance implementation. By leveraging our regulatory knowledge, testing governance methodologies, and end-to-end process understanding, Monticello supported the tangible business outcomes for our client to ensure readiness for this significant shift in the oversight and transparency of SBS trades in the financial services industry.
[1] https://www.isda.org/book/sec-initial-margin-bolt-on-supplements/
[2] https://www.sec.gov/news/press-release/2021-65
[3] https://www.sec.gov/opa/Article/press-release-2012-67---related-materials.html
[4] https://www.sec.gov/page/exchange-act-substituted-compliance-and-listed-jurisdiction-applications-security-based-swap
[5] https://www.sec.gov/news/press-release/2021-57
[6] https://www.sec.gov/news/press-release/2021-138
