It may seem premature to be thinking about September 2022, the point the final phase of the initial margin (IM) rules for non-cleared derivatives will come into effect. It’s not. Phase five in September this year underlined the challenges in-scope firms will face and the need to start preparing early, particularly when it comes to custodian onboarding. Fortunately, the recent publication of key custodial documents on the ISDA Create online negotiation platform points to a path forward that will make the compliance process simpler and more efficient and save phase-six firms time.
Last week, ISDA announced that Bank of New York Mellon will negotiate its triparty and third-party account control agreements with market participates on ISDA Create, enabling full digital capture of the resulting legal data. Having both custody and regulatory IM documentation available on ISDA Create will bring real efficiencies to in-scope entities and help reduce the burden of phase-six compliance.
This will go some way to resolving some of the challenges experienced during phase-five implementation. While the larger firms that had previously complied had used a small number of triparty custody providers with relatively standardized documentation, the firms caught by phase five tended to opt for the third-party model, designed for the needs of smaller entities. However, the documentation for third-party services may be extensively negotiated to account for client and dealer preferences – a mostly manual process that was time consuming and resource draining.
The sheer number of entities likely to be in scope – estimated at about 750, more than double the number caught by phase five – means bottlenecks are likely if firms take a bilateral approach to negotiation. This happened with phase five, resulting in many entities only having credit support documentation and custodial arrangements in place for a portion of their counterparty relationships by September 1. This meant firms had to trade with a smaller number of counterparties than usual or trade within the limits of their IM thresholds (ie, less than €50 million in exposure per counterparty group).
Of course, there were other reasons for the backlogs and bottlenecks – extensive know-your-customer requirements, fewer resources available to smaller entities and less automation of margin processes than larger firms. All of this explains why the availability of custodial documentation on ISDA Create and the ability to negotiate online is so important.
September 2022 may seem like a long time away, but firms need to start preparing now. Phase six is likely to be further complicated by the fact that many smaller entities have their derivatives portfolios managed by multiple asset managers through separately managed accounts, meaning preparations are dependent on each phase-six entity calculating its swaps exposures and disclosing to its asset managers if it expects to breach the threshold for compliance. If these calculations and disclosures are submitted late, it threatens to delay the implementation process.
Tools like ISDA Create and the Standard Initial Margin Model, along with ISDA’s standard documentation, eligible collateral templates and Margin InfoHub, mean market participants have the tools they need to comply. We urge firms to take advantage of these and start getting ready now.
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