December 6th, 2017 by Nick Railton-Edwards
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With a scant 28 days until the MiFID 2 starting gun sounds, Regulatory Change managers could be forgiven for looking forward to a well-deserved rest. In reality, 3 January 2018 will actually represent the beginning of a long process of clarification, refinement and final implementation. In this slightly dispiriting context, it is not surprising that market participants have focused on pushing their Sisyphean boulder to the top of Mount MiFID 2, perhaps remaining oblivious to the rumble of avalanche further up. Failure to comply with MiFID 2 by the deadline will at worst lead to some uncomfortable conversations with your Regulator; failure to comply with margin regulations will result in the same, along with a more consequential prohibition on trading by and with all non-compliant parties.

The deadline for Phase 3 Initial Margin is 1 September 2018. The recent history of earlier phases inspires little confidence in a successful round 3:

  • IM/VM Phase 1. Deadline- 1 September 2016. 22 groups. Result- failure to complete custody documentation left approximately half the market unable to trade on the first day
  • VM Phase 2. Deadline – 1 March 2017- all remaining financial counterparties, or non-financial counterparties trading non-cleared derivatives in the EU, US, Japan, Canada, Switzerland and Singapore. Result- a reported 40% compliant by the deadline with only 10.45% of documentation loaded in reference systems and useable. Regulators granted forbearance until 1 September 2017
  • IM Phase 2. Deadline 1 September 2017. 6 new groups. Result- >90% compliance for HQ entities. Negotiations continue in respect of subsidiaries.

With a few exceptions (including all DRS clients); to date, the market-wide timely implementation of global margin regulations has been less than impressive. There is no comfort to be gleaned from the relatively smooth rollout of IM Phase 2- Phase 3 represents an order of magnitude increase in the affected population. Even following strenuous edge-case portfolio compression efforts, conservative estimates put the Phase 3 population at approximately 60 groups. A (very) back of the envelope calculation puts the Phase 3 requirement at 36,000[1] documents. Not an insurmountable number assuming standardised documents, limited negotiation points, widespread market knowledge and sufficient time. Unfortunately, for IM none of these factors apply. Each document in the IM suite is complex, they will have to be negotiated in different combinations and must all be harmonised with respect to each other. Aside from a handful of large law firms and an even smaller number of specialist consultancies[2], practical IM knowledge is confined to the 28 banks who have already undergone the experience. September 2018 seems some distance away; this is an illusion- the relevant custodians have already indicated they require executed customer agreements in place by the end of May 2018. Once again, fully negotiated agreements count for little until they are entered into reference data systems.

It is a truism that project success is predicated upon the quality of initial planning; rarely truer than in the case of Phase 3 IM. The work can only begin once key stakeholders throughout the enterprise understand the extent to which they will be affected by IM- at this point, and subject to operational constraints, fundamental decisions can be made with respect to counterparty prioritisation, SIMM elections, regime tables, threshold allocations, collateral schedules etc. Although Phase 3 represents a significant challenge for new entrants to the IM regulations, neither should phase 1 and 2 “veterans” rest on their laurels. In the rush to comply with earlier phases, a number of tactical decisions were made, preferencing timely compliance over collateral optimisation and operational efficiency. There is a large distance between technical, box-ticked compliance and the enterprise-wide implementation of the most efficient processes possible. These two destinations differ mainly in when the journey began.

[1] Conservatively assuming 60 “new” Phase 3 entities needing to document 30 relationships (across all phases), 5 documents per suite (inc. collateral schedules), 4 entities per group

[2] To our knowledge- only DRS

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