Preparing for the initial margin phase-in

Requirements for the mandatory exchange of initial margin (IM) are expected to be time‑consuming and laborious to implement. David White, head of sales at triResolve, discusses the lessons learned from in‑scope firms, obstacles to achieving compliance and how automation can increase operational efficiency

The mandatory exchange of IM is being phased in based on a notional threshold amount that will reduce over time. The largest firms began exchanging IM in September 2016, and the final group of firms will come into scope in September 2020. 

Preparation for meeting these requirements will take significant time and involve intensive efforts to ensure systems, processes and documentation are in place, according to the International Swaps and Derivatives Association (ISDA).  

Regardless of when a firm comes into scope, the time to begin preparing is now.

TriOptima has helped many phase one and two derivatives dealers meet their IM requirements. With vast experience in valuation and collateral management, it understands the complexities of the regulation and is ideally placed to help firms overcome the challenges. 

To aid the market’s compliance efforts, David White, head of sales at triResolve, highlights the lessons learned from in‑scope firms, the key challenges to achieving compliance and how firms can increase operational efficiency by automating the process.    

 

What trends has TriOptima observed so far among firms in phases one and two?

David White: There are many, but the overriding trend is the market’s adoption of ISDA’s standard initial margin model (SIMM™). If you review the IM rules, they dictate that firms can calculate IM in one of two ways: either through a regulatory‑approved model or via a schedule‑based percentage-of-notional approach.

The latter doesn’t really allow for netting and is quite expensive, so the ISDA SIMM™ has provided exactly what it says on the tin: a standard way for the market to calculate IM via an approved model. 

 

What are the key challenges firms face in complying with the IM requirements?

David White: I think there are three big challenges: calculating inputs, managing margin calls and resolving disputes. 

Calculation is arguably quite easy, as firms can access this off the shelf from ISDA. The challenge arises in calculating the inputs to the ISDA model on a daily basis. This requires the calculation of trade‑level sensitivities, which has proved onerous. 

The next hurdle arises once those inputs have been calculated and fed into the model: how are you then going to efficiently agree and exchange those margin calls with a counterparty? 

Finally, there is the challenge of dispute resolution. Despite using the same method to calculate IM amounts, differences will inevitably arise when input data differs to your counterparty data. You need to be able to reconcile sensitivities to pinpoint dispute‑driving differences and establish a coherent dispute-resolution process.

How can automation help, and where is it most effective?

David White: Firms should be looking to automate both their IM and variation margin (VM) processes. 

Through automation, resources can be freed up to focus on exceptions. In doing so, firms will have more time to resolve disputes. By prioritising dispute resolution, there is less risk to the firm and the market as a whole. 

For TriOptima, this is key – firms should unquestionably be automating the margin call exchange and agreement. In terms of dispute resolution, there must be an efficient way to identify and reconcile sensitivity differences, and a method to highlight the differences between what are driving disputes on any one day.

 

What factors should firms consider when developing an automation strategy? 

David White: To automate this process, a bifurcated collateral management model cannot be used. Instead, which vendor can provide a solution for all parts of the process – IM and VM – must be considered.

Can the solution your firm is adopting calculate inputs to the VM process? Can the vendor your firm is looking at produce inputs to the IM calculation sensitivities? Can your firm have an automated process around the exchange and agreement of margin calls, and does it have an automated and efficient way to resolve disputes with counterparties?

A vendor that can answer all of these questions and has seamless dataflow between all constituent parts will maximise the chance of implementing an operationally efficient solution.

 

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