ISDA Chief Executive Officer Scott O'Malia offers informal comments on important OTC derivatives issues in derivatiViews, reflecting ISDA's long-held commitment to making the market safer and more efficient.
The final implementation phases of the initial margin (IM) requirements for non-cleared derivatives will bring hundreds of new entities into scope of the rules, affecting thousands of counterparty relationships. This will, in turn, drive a big increase in daily margin calls, settlement volumes and collateral disputes that could put a real strain on the industry unless market participants seize the opportunity to transform and automate their collateral management processes.
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At ISDA, we have been working to improve the collateral process to bring greater operational efficiency, with a strong focus on new mutualized operational solutions, best practices and greater automation.
For the smaller entities that will come into scope under phase five on September 1 and phase six on September 1, 2022, the IM rules pose a significant compliance burden. As I have written previously, exchanging IM in line with the rules requires diligent preparation over a period of at least nine to 12 months. From setting up relationships with custodians to negotiating documents and testing systems and processes, in-scope firms need to prepare well and prepare early.
But there is also an opportunity to leverage industry solutions to bring greater automation and efficiency to collateral management. By implementing a portfolio reconciliation and dispute resolution program, for example, firms will be better prepared to manage disputes, while automating the collateral management process will put them in a better position to deal with the increase in margin calls and settlements.
Fortunately, phase-five and phase-six entities can benefit from the platforms and technologies that were developed for earlier phases, enabling them not just to meet the requirements but to enhance operating processes at the same time. For example, the ISDA Standard Initial Margin Model means firms don’t have to develop their own IM calculation methodology but can instead use an industry model that has been developed and refined over time. ISDA Create drastically reduces the time, resources and risks associated with negotiating legal documentation, while the Common Domain Model allows data and information from those documents to be fully digitized and passed seamlessly to other systems and processes.
Firms also have an opportunity to use the IM compliance process as a springboard to transform collateral management. In 2017, ISDA published a blueprint for the future of collateral processing and, more recently, we developed a series of collateral management transformation toolkits. These toolkits provide resources to help firms identify opportunities to improve their collateral management in key areas, including onboarding custodians for segregated accounts and automating collateral processes.
There is no regulatory requirement to automate collateral management, of course. But by understanding the challenges firms faced in the earlier IM phases and the tools they developed to meet those challenges, smaller entities in phases five and six can realize significant efficiency gains that have the potential to extend well beyond the exchange of margin.
As the phase-five deadline approaches in a few weeks’ time, preparation for phase six will crank up next month. We know that phase six will be the heaviest lift, given the hundreds of firms involved and the amount of preparation required. Using this opportunity to automate key processes and transform collateral management as part of their compliance will ensure they are fully prepared for the derivatives market of the future.
Source: ISDA