Is the buy-side ready for the uncleared margin rules?
AcadiaSoft CEO Chris Walsh and his team have been with the industry every step of the way since the rules were first implemented in September 2016, and have since been working tirelessly to ensure that all firms – from the biggest banks to the smallest hedge funds – can seamlessly comply with the new initial margin requirements.
After the financial crisis, the Basel Committee on Banking Supervision (BCBS) and the International Organisation of Securities Commissions (IOSCO) introduced a new set of regulations that significantly changed the existing margin framework of the uncleared derivatives market. The uncleared margin rules (known as “UMR” to industry insiders) standardize the posting and collecting terms of variation margin and introduce a new requirement for the posting and collection of initial margin.
Beginning with the largest banks in September 2016, the UMR were initially established over five annual phases, determined by a firm’s “Average Aggregate Notional Amount,” which is calculated by the total outstanding amount of non-cleared derivative positions during the prescribed observation period on a gross notional basis.
In July 2019, BCBS and IOSCO agreed to add a sixth phase to the implementation period, extending the final deadline to September 2021. Over the next two years, hundreds of buy-side firms will be coming into scope for the rules.
As the industry scrambles to prepare for the final phases, Traders Magazine’s Editor John D’Antona Jr. sat down with Walsh to discuss AcadiaSoft’s role in the UMR race and what’s next for the regtech firm.
Traders Magazine: Tell us a little bit about the history of AcadiaSoft and how the company has evolved.
Chris Walsh: AcadiaSoft was created as a direct response to the financial crisis and the new regulations that were implemented as a result of the crisis. Our initial focus was collateral management. We standardized collateralization, taking a manual process and transforming it to completely electronic communication.
While we were busy eliminating email, the regulators were about to set into motion a new set of standards that would reset the framework for the uncleared derivatives market, which we know now as the Uncleared Margin Rules. Once the rules were announced, we set out to develop solutions that could be seamlessly integrated while mitigating risk and improving efficiency.
As a result, we developed the only industry-wide solution that directly addressed the enormous operational challenges large banks faced in complying with the new margin requirements that went into effect in 2016, and continued to work diligently with the industry – collaborating with market participants and trade associations like ISDA – as the subsequent phases went into effect over the past three and a half years. Now, 99% of firms that are currently in-scope for the regulations are engaged with AcadiaSoft, and we’re working closely with the firms that will fall into scope over the final two years of the implementation period.
TM: AcadiaSoft has been a key player in addressing the Uncleared Margin Rules, and with four phases down and now two final phases to go, how do you think the implementation period is going?
Walsh: While there were certainly some hiccups following the implementation of phase 1 in 2016, phases 2-4 went relatively smoothly. This is a testament to the collaboration across the industry that was achieved as a result of these regulations. AcadiaSoft was built as an industry collaborative, backed by 16 major market participants and infrastructures. Rather than firms looking at the challenges individually, we set out in the beginning to bring the industry together, define what solutions would work and deploy these solutions in a complementary way. We’ve also had tremendous success working with vendor partners like TriOptima, DTCC and Cloud Margin on collateral and risk management tools.
As we reach the final push for UMR implementation, we remain full steam ahead. All in all, we anticipate that more than 1000 firms will fall into scope over the next two years, primarily affecting the buy-side. These are the smallest firms to be affected by the rules – and they lack the budgets and infrastructure of the firms that went into production in the earlier phases. Now that the final phase has been broken into two segments (September 1, 2020 for firms with gross notional threshold ranging from $749.9 BN to $50 BN and September 1, 2021 for firms with gross notional threshold ranging from $49.9 BN to $8 BN), our task is to continue to work with phase 5 firms to get them onboarded for September 1, 2020, provide the tools and resources needed for firms to gauge if and when they will fall into scope for the rules and ultimately to ensure all firms are operationally ready ahead of the deadline, whether it is in 2020 or 2021. Right now, we are looking at about 300 firms that will be in-scope in 2020, and another 800 in 2021.
TM: With the final phases of UMR on the horizon, what are you focused on next?
Walsh: Collateral is still the principal risk mitigant in the post-trade derivatives space. Our electronic messaging business was initially driven around the exchange of margin calls and confirmation of what collaterals will be exchanged between parties. This evolved into the AcadiaSoft Hub, which standardized and integrated margin calculation, reconciliation and communication, disputes management, and collateral transfer. Now with AcadiaPlus, we take firms through the entire risk mitigation lifecycle from exposure calculation to collateral settlement. This ensures optimum efficiency in their daily margin, collateral and settlement processes and provides a secure place to store and share post-trade data and analytics. Most notably, it allows firms to connect directly with any third-party necessary to complete the post-trade cycle – whether or not that firm is engaged with AcadiaSoft – which is rare in the fintech space.
Once the uncleared margin rules are completely phased in, the industry will become more laser-focused on reducing cost and increasing efficiency. The legal agreement negotiation process alone has approximately $2.5B in costs associated with it, and we’ve been able to reengineer that process by digitizing it, which can reduce that cost dramatically. By digitizing the legal agreements process, we believe we can save the industry more than $1B in total through increased cost efficiency.
TM: What do you see as the biggest regulatory challenges facing the industry over the next few years?
Walsh: In Europe, there’s obviously the uncertainty surrounding Brexit and what that could mean for the regulatory landscape. Globally, there’s the move away from LIBOR to SOFR. Moreover, across the board, firms are facing additional capital regulations that impact how they organize and operate. Dealing with regulations can and has become all-consuming, particularly when it’s coupled with a tremendous pressure to cut costs. Regtech firms will play an increasingly pivotal role to help the industry address these regulatory challenges – and might even encourage more industry collaboration along the way.