SPONSORED COLUMN: The next layer of derivatives reform

Paul NorthPaul North, head of product management EMEA at BNY Mellon, looks at how custodians and service providers are responding to margining rules set to come into force this year. Derivatives users now have certainty on the timetable for central clearing of interest rate swaps (IRS) in Europe, but they can ill afford to ignore the upcoming changes to bilateral margining of less liquid instruments. Under the European Market Infrastructure Regulation since November 2015, market participants can mark in their diaries the dates for frontloading and clearing IRS. Other liquid swaps will follow, but existing contracts and many less liquid swaps will be subject to new margining rules for non-cleared derivatives, starting September 2016, based on guidelines drafted by the Basel Committee for Banking Supervision and International Organisation of Securities Commissions. The new margin obligation will apply to transactions between financial counterparties and the non-financial counterparties exceeding the clearing threshold. In a mechanism that reflects margining of cleared derivatives, both initial margin (IM) and variation margin (VM) requirements are considered. The exchange of VM covers current exposure and will be one-way at any one time. IM to cover future exposure will be two-way throughout and might be calculated using either a quantitative portfolio margin model or by reference to a standardised IM schedule against percentage of notional exposure. For systemically important derivative market participants, both IM and VM must be exchanged from September 2016. However, market participants with lower notional exposures will have staggered IM implementation dates based on thresholds starting at €3 trillion in 2016 and falling progressively each year to €8 billion in 2020. The exchange of VM will be far more abruptly implemented, with a second deadline occurring in March 2017. To date, uncertainty about the timeline for central clearing has overshadowed non-cleared margin rules. Now that they are gaining attention, the impact of margin exchange on non-cleared derivatives will raise more questions. For example, what available assets might derivative contract-holders have that meet the collateral eligibility requirement? And if they don’t have assets immediately available, what will be the cost of obtaining such assets? Other systemic risk questions also remain open, such as the effect on liquidity for margin-eligible instruments.  Service providers and custodians have been developing products and solutions. In relation to the eligibility requirement for IM collateral, derivative contract holders will need to identify how to use their existing assets to obtain eligible collateral. This could be achieved through the use of collateral transformation programmes such as securities lending, or repo transactions if delivering cash to a counterparty. Both the securities lending and repo markets are accessible via custodians, which are evolving their capabilities to facilitate demand.  To counteract concerns over collateral scarcity, custodians have developed collateral optimisation solutions, ensuring that contract-holders retain their most valuable liquid assets for trading and use less liquid assets as collateral. As well as reviewing the capabilities of service providers, market participants will also need to reappraise their internal processes, with a view to greater co-ordination across desks to improve collateral efficiency. Moving from a bilateral collateral model, which includes terms to minimise daily effort, to a daily VM and periodic IM model, will require changes to infrastructure and additional effort. The views expressed herein are those of the author only and may not reflect the views of BNY Mellon. This does not constitute investment advice, or any other business, tax or legal advice, and should not be relied upon as such. ©2016 funds europe

Sponsored Profiles

SPONSORED FEATURE: Investing for income

May 17, 2017

Portfolio Manager Thomas Kruse examines the findings from Pioneer Investments’ survey on income investing and outlines ways of achieving a target income.

SPONSORED ARTICLE: A radical solution to KYC concerns

May 17, 2017

The 1MDB affair shows that lax know-your-customer and due-diligence procedures are a major risk, says Paolo Brignardello, head of product management and marketing, Fundsquare. New solutions are...

SPONSORED FEATURE: AIFMD - What does Brexit mean?

Apr 18, 2017

An open discussion between funds industry experts and initiated by SGG Luxembourg took place in London to examine  the implications of Brexit for UK fund managers marketing to the EU.

SPONSORED FEATURE: Luxembourg fund reporting – CRS vs FATCA

Apr 18, 2017

Luxembourg funds need clear procedures for CRS compliance, writes Andrew Knight, Partner at M Partners, a member of the Maitland network of law firms.

Executive Interviews

INTERVIEW: Finding managers that can (and do)

Apr 18, 2017

Fabrice Kremer, a fund selector at Banque de Luxembourg Investments, has berated fundamental managers for failing to beat indices, but he remains committed to active funds. He speaks to Nick...

JERSEY INTERVIEW: ‘A steady sort of place’

Mar 21, 2017

The chief executive of Jersey Finance is keen to portray the island as a stable, trustworthy jurisdiction. He talks to George Mitton.



May 17, 2017

With such an intangible product, it can be hard for asset managers to communicate what they do. Having personality and connecting with customer aspirations may be the key, our branding roundtable hears.

ROUNDTABLE: The issue is perception

Mar 21, 2017

Our panel discuss tax transparency, the elegance of private placement and why Jersey could do more to promote itself. Chaired by Tom Cowsill in Saint Helier.