Fund managers adapt to life under new margin rules

Some two weeks after the latest phase of the uncleared margin rules took effect, firms at the heart of that process said the implementation went well but there are still plenty of clients to onboard, and the next round in September next year will be a much larger undertaking.

The fifth phase of the uncleared margin rules (UMR) was introduced on September 1, meaning firms with more than $50bn (£36bn) of uncleared swaps had to start posting margin against those positions.

The fifth round of swaps regulation is unlikely to knock Emma Raducanu off anyone’s front page but this latest phase is note-worthy because the lower threshold means that fund managers are in scope for the first time.

Historically, fund managers have had little interest in such matters and leant on their custodians to keep them on the right side of the law but this time round the onus for compliance is largely on the client.

Banks like BNY Mellon are supporting their asset manager, hedge fund and pension fund customers by providing the infrastructure for compliance and links to margin hubs like LCH SwapAgent.

Ted Leveroni, managing director at BNY Mellon, said “the implementation was challenging and successful in equal measure”.

“The fact the threshold was set at $50bn enabled firms to prioritise which accounts to open by September and which could wait. This allowed us to focus on the largest accounts and counterparties, and turn what could have been one massive wave into a large wave with a steady flow after that,” Leveroni said.

BNY said it has so far switched on “several thousands of accounts” which represents the “majority of accounts in scope”. Leveroni said this posed operational challenges but the bank implemented internal changes to support the increased demand.

The DTCC’s Margin Transit Utility is a key piece of market structure to enable firms like BNY and State Street, which linked its collateral service to the MTU in August, to post margin on behalf of their clients.

Bob Stewart, executive director of institutional trade processing (ITP) at DTCC, said: “Interest accelerated in the past four to six weeks as more market participants approached us asking what we had to offer. On the implementation date of September 1, a number of new clients signed up for the service to help facilitate the movement of their collateral.”

Stewart added: “We haven’t seen huge volumes because that is dependent on how the clients trade and the market moves but they are clearly preparing themselves to use tools that aid in the overall processing of collateral.”

Stewart believes margin volumes will pick-up when we enter the next wave of volatility as asset managers and hedge funds have to trade to hedge their positions.

There is a feeling firms may have been limiting their use of the derivatives that count towards their UMR totals to ensure they are not bound by the rules.

Stewart said: “I get the sense that, since implementation of phase five, clients have reduced activity slightly but fundamentally if you have a strategy, you have a strategy and you need to move forward on it. So if there has been a pull-back, I think that will be short-term to get a better sense of how everything works.”

Ankeet Dedhia, Americas head of FX product at ForexClear, part of LCH, said firms have long been adapting their trading strategies to avoid the margin rules. He said his foreign exchange clearing service saw volumes increase ten-fold in 2016 as banks started to clear their FX options and non-deliverable forwards rather than trade in the over-the-counter market and have them count against their UMR totals.

Dedhia said: “We expect to see a similar trend on the buy-side – we are already seeing early signs of this trend since a record number of clearing brokers have onboarded to ForexClear in 2021 to enable buy-side clearing, with more clearing brokers expected to onboard in Q4 2021 and 2022.”

He added: “We also have some asset managers and regional banks who have onboarded and have started clearing FX in 2021, while many others, including some hedge funds are in regular discussion about FX clearing, and looking for solutions to reduce UMR margin costs, counterparty credit risk and streamline their operational workflows.”

Phase five, then, has gone relatively well but the consensus is that next year’s final phase, when the threshold drops to just $8bn, will be more challenging.

Dedhia said: “A recent ISDA (International Swaps and Derivatives Association) report estimated that around 315 buy-side firms will be impacted in phase five of UMR implementation and about 775 in phase six, so the bigger impact will likely be next year.”

Stewart is urging clients caught by the next phase of UMR to start their preparations sooner rather than later.

“Phase five was rather a frantic race towards the end; therefore I am advising clients to look strategically at their book to understand what the requirements are and to plan accordingly. I’m also recommending that preparations start much earlier in the process to prevent a rush at the end, such as that we experienced this September,” Stewart said.

Leveroni sees the work on phase five blurring into preparations for the September 2022 deadline.

“While we are still onboarding accounts for phase five, we are already opening accounts for phase six clients coming in early. With previous phases there has been a lull of activity immediately after implementation but we are seeing no drop-off in demand this time round.”

Leveroni concluded on a note of caution: “That said, phase six firms will include for the first time pensions funds, most of which use external managers and don’t tend to be members of the trade associations advising on UMR. We will need to be as or even more pro-active with pension funds in phase six as we were with the firms in phase five.”