Roughly a year away from the next deadline for compliance with the Uncleared Margin Rules (UMR), which was extended in view of disruptions from Covid-19, a survey finds that a vast majority of the affected institutions are not prepared for the different aspects of the regulation.
According to the State Street survey, which was fielded by Oxford Economics in June 2020, 81% of firms with a September 2021 (Phase V) or September 2022 (Phase VI) deadline lag in their preparations for the UMR, which were set in motion in 2009 to reform the over-the-counter (OTC) derivatives market following the global financial crisis.
“UMR signifies a major change in the industry that aims to bring greater stability and transparency to the OTC derivatives market,” Nadine Chakar, head of global markets at State Street, said in a statement. “As we approach the deadline for the next phase, it is critical for buy-side firms of all sizes to be aware of the pending requirements and to not only effectively manage, but optimize, their liquidity and collateral needs with the right solutions and technology in place.”
Of the 300 asset managers and asset allocators in 16 countries who participated in the survey, 86% are preparing for Phase V or VI, representing a big proportion of buy-side firms coming under the purview of UMR in the next two years. These institutions face a steep learning curve as many are unfamiliar with Initial Margin rules and operations.
For those in the preparation stage, only 19% say they are fully prepared for compliance, 42% are preparing in all relevant functions, while the remaining 39% have begun preparations in just a few areas.
Nearly eight in ten of the firms have not agreed on how to approach settling segregated collateral with counterparties. As it stands, third-party custody with account control agreements remains the favoured approach among respondents. Many firms underestimate the difficulty associated with compliance with UMR. While 68% of those preparing for compliance are very confident in their ability to handle the new workflows, 80% of those in compliance say the face challenges in incorporating them.
As institutions move toward the compliance stage, half expect these requirements will ultimately have a positive impact on overall operations. Forty percent of the smaller firms surveyed anticipate a negative impact, compared to just 20% of larger firms. Public pensions were most likely to expect a positive impact, while corporate pensions were most likely to anticipate a negative impact.
Institutions are using mitigation strategies and have turned to third parties to ease the burden of complying with UMR. About 80% of those in compliance functions have indicated that they have faced some degree of challenge in incorporating new workflows. To ensure on-time compliance, the majority of firms are employing a mix of in-house capabilities and outsourcing to third parties with operational expertise.
According to the survey, 56% of firms are planning to adjust strategies by reducing OTC contracts to limit the impact of UMR. For those already in compliance, 80% reported a reduction. The majority are using compression strategies to limit UMR’s impact. Firms will seek various optimization strategies with third parties.
“The key to any regulatory compliance is to look at all the requirements and objectives holistically,” says Gino Timperio, head of funding and collateral transformation at State Street. “While it’s tempting to circumvent the complexity of UMR by simply reducing the volume of in-scope contracts, I’d argue this approach is short-sighted. Recent market volatility underscores the need to consider collateral, funding and liquidity at a firm-wide level, and buy-side firms should adopt a strategic approach to UMR compliance, with the right external support to manage some or all components of the process.”