We’ve seen several reports and articles lately on collateral and risk management for non-cleared derivatives, including submissions from OMGEO, DerivSource and Finadium/Murex. The indication is that the topic is heating up. What are these papers saying and which ones should you read?
The OMGEO report, “Collateral Management for Non-Cleared Derivatives: A Practical Guide,” covers four areas that any participant in the OTC derivatives markets should take:
1) Building an integrated view of collateral
2) Effectively using the inventory
3) Integrating and automating margin workflow
4) Designing your solution to support future needs
Under each category are a number of bullet points, the majority of which could be expected, that form a to-do list for ensuring readiness for the new non-cleared derivatives collateralization regime starting in December 2015.
A July 29 2014 DerivSource article, “Collateral Damage: Uncleared Derivatives Margin Requirement,” is a review of the main points then a discussion of who will be affected. The article does a good job of discussing what rules are known, what is guessed at and how market participants are responding. Quoting our colleague Nick Newport at InteDelta, “There’s probably at least 70% of the new regulations which you could say are pretty final and largely most people agree on what the rules should look like…. There’s probably about 10% where we are not at all clear and 20% which could go one way or the other. Most of the large banks are comfortable enough to go ahead and start implementing the vast majority of the elements as everything needs to be in place by December 1, 2015. The large banks can’t wait much longer to start implementing because it will take a long time.” Questions remain however how prepared small participants are for the changes ahead. On a related note, DerivSource is holding what looks to be an interesting webinar on September 10, “Cleared & Uncleared Derivatives: How to Tackle Margin Requirements in Tandem?”
The June 2014 Finadium report, “Preparing for Risk-Based Margining of Non-Cleared Derivatives (free courtesy of Murex),” is more technical than the OMGEO or DerivSource pieces, and focuses on the operational and risk management aspects of collateral for non-cleared derivatives. There is also a discussion on the different models that market participants could use and ISDA’s support of the Standard Initial Margin Model. This gets into the category of figuring out how the new rules will work in practice. According to the report, “Rather than adopting multiple models, ISDA advocates that all market participants use one model for calculating Initial Margin requirements to enable transparent reconciliation operationally. This would eliminate much market and regulatory confusion for IM management. In addition, ISDA has suggested that bucketing trades by trade type is a challenging exercise in the non-cleared derivative space; each trade type can have multiple exposures and multiple, perhaps an excessive, number of risk calculations. ISDA argues that this makes the reality of each firm utilizing their own IM model as impractical and unrealistic.” What models banks use to calculate margin for non-cleared derivatives is a vitally important issue that still needs to resolved.
The upshot to these publications is that for firms that expect to trade non-cleared derivatives, now is a good time to figure out how internal processes should be organized. Its a complicated process and while, as noted, 70% of the rules are known, the other 30% is going to take some real work to figure out.