Firms are unprepared for Uncleared Margin Rules despite deadline extension, says State Street survey
Eighty one per cent of institutions with a September 2021 (Phase V) or September 2022 (Phase VI) deadline for the Uncleared Margin Rules (UMR) are unprepared to comply with all facets of the new regulations, according to a survey by State Street.
The survey measures the perceptions, plans and readiness of 300 asset managers and asset allocators in 16 countries around UMR, which were set in motion in 2008 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,” says Nadine Chakar, head of State Street Global Markets. “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 optimise, their liquidity and collateral needs with the right solutions and technology in place.”
The survey found that roughly a year away from the next deadline, which was extended due to Covid-19, firms remain primarily unprepared for the different aspects of the regulation.
The surveys reveals that institutions are in different stages of compliance preparedness by both phase and function.
The vast majority (86 per cent) are preparing for Phases V or VI, representing the significant 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 (IM) rules and operations.
For those in the preparation stage, only 19 per cent say they are fully prepared for compliance. Some 42 per cent are preparing in all relevant functions, while the remaining 39% have begun preparations in just a few areas.
Nearly 8 in 10 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 amongst respondents. Many firms underestimate the difficulty associated with compliance with UMR. While 68 per cent of those preparing for compliance are very confident in their ability to handle the new workflows, 80 per cent of those in compliance said they faced challenges in incorporating them.
As institutions continue toward the compliance stage, half expect these requirements will ultimately have a positive impact on overall operations. Forty per cent of the smaller firms surveyed anticipate a negative impact, compared to just 20 per cent 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. E
Eighty percent 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.
Over half (56 per cent), meanwhile, of firms are planning to adjust strategies by reducing OTC contracts to limit the impact of UMR. For those already in compliance, 80 per cent reported a reduction. The majority are using compression strategies to limit UMR’s impact. Firms will seek various optimisation 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.”