Remaining resilient

Securities Services, technology

Remaining resilient

03 April 2020

As the Covid-19 pandemic triggers record levels of activity in the securities and derivatives markets, 20 industry associations have called for a delay in implementing the fifth wave of initial margin requirements for uncleared derivatives. flow’s Janet Du Chenne assesses how resilience in securities services is providing buy side and sell side firms with silver linings, despite the dark clouds overhanging them

Responding to talk of the system-wide margin call1, 20 industry associations which represent derivatives firms wrote a joint letter to the Basel Committee on Banking Supervision and International Organization of Securities Commissions (BCBS IOSCO) asking for a delay in implementing the fifth wave of initial margin rules for uncleared derivatives, or uncleared margin requirements.

Published last week, their letter states that while market participants have been working diligently to meet the final phases of these important compliance dates, they continue to deal with the fall-out from the Coronavirus epidemic and the volatility in the derivatives markets (see Figure 1). Consequently, they lack the bandwidth to support documentation and operational requirements for the regulatory initial margin (IM) compliance dates on September 1, 2020 (Phase 5) and September 1, 2021 (Phase 6).


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  Mar 20  Mar 19  Change
Financial derivatives: Traded contracts Eurex Exchange       
   European equity index derivatives (million)  193.2 101.2  +91% 
   European equity index derivatives (million)  68.1  64.2  +6%
   European equity derivatives (million)  32.6  36.9  -12%
   Total1) (million)  296.0  203.3  +46%

Source: Eurex Exchange

Under the BCBS IOSCO requirements2, participating firms would be required to adopt infrastructure enabling them to post initial margin, or collateral, to offset their trade exposure as mandated by the European Market Infrastructure Regulation. EMIR entered into being in 2012 in the wake of the systemic failure that was a root cause of the 2008 global financial crisis.

Since September 2016, new collateral requirements for bilateral over-the-counter (OTC) derivatives have been gradually phased-in. The associations’ letter follows a report last week that the European Commission currently has no plan to implement any delays to Phase 5 of the rules.

As reported in Global Custodian magazine, more than 300 firms with derivatives exposure in excess of US$50bn are expected to come under the new IM rules, and will still have to use the time they have left to put in place know-your-customer (KYC) checks, onboard a segregated custodian, and have all the related documentation in place.


Voicing concerns

In the near term, noted the association’s letter, the industry is generally functioning well thanks to business continuity plans. However, with the displacement and repurposing of staff of recent weeks, work from home is limiting access to legal and operational documentation and limiting abilities to communicate with counterparties. “Due to market volatility, firms are avoiding infrastructure updates and may be unable to complete, deploy or test infrastructure needed to support regulatory IM requirements,” said the letter.

Since the overall impact of Covid-19 may not be known for some time, the industry letter suggests that the schedule for the implementation of further phases of the IM requirements be delayed and reconsidered when relevant facts and circumstances are known. “When markets are back to normal conditions and new Phase 5 and Phase 6 compliance dates are to be set, we kindly request that sufficient lead time be provided in order to complete implementation in a phased and reasonable period,” it asks.


Onboarding custodians

The rules require market participants to appoint an independent third-party custodian with the legal and operational infrastructure in order to post margin and report collateral positions to the regulator. Here, the letter added, the pandemic has also resulted in a significant delay for both custodians and buy-side firms in carrying out heavy onboarding tasks, as well as a delay in legal negotiations between counterparties.

“Additionally, while firms need to complete custodian documentation, the custodians are subject to the same strained working conditions as the firms coming into scope,” it said. “We note that the ability of global custodians to facilitate client onboarding is already being impaired, extending further the lengthy process to establish compliant custodial accounts. Similar challenges are likely to affect the availability of vendors which provide services critical to IM implementation.”


Segregating assets

In addition, the rules are driving the protection of client assets by requiring that assets be held in segregated accounts at the custodian and at the custodian’s sub-custodian and not be comingled with other assets. While it is believed that many of the larger derivatives firms have appointed a global custodian, others have yet to do so before the proposed IM deadline.

“Given these unprecedented events and change, it’s even more important for securities services providers to engage with clients on a choice of services and solutions, including the ability to provide segregated accounts and facilitate the movement of collateral to mobilise that collateral as and when it is needed,” says Michaela Ludbrook, Global Head of Securities Services, Deutsche Bank.

She adds that Deutsche Bank Securities Services has leveraged its robust infrastructure to support clients with fully operational home working teams and a resilient and stable model.


Operational resilience to the fore

Clearly, this crisis brings the concept of operational resilience to the fore – and provides a live test case for the FCA’s operational resilience review, which kicked-off in December 20193 before the onset of Covid-19.

Operational resilience places high on the FCA’s agenda and is a topic that many have approached differently as evidenced by the current crisis. For some, naturally, their investment priorities have been focused on driving returns and revenues as they grapple with fee compression and margin squeeze. In a letter to shareholders, Blackrock chief exec, Larry Fink, this week wrote that “too few” had “invested in innovation to build resilience and stay ahead of emerging trends that are impacting the industry in full force today.”4

Meanwhile in securities post-trade, regulatory and infrastructure change and new entrants have catalysed more focused investment in robust infrastructure and future state solutions over recent years and participants continue to prove their resilience with operating models that enable clients to focus on their core business.

Speaking to flow, Virginie O’Shea, post-trade FinTech analyst, asserts that the industry has fared relatively well so far under extremely challenging circumstances – albeit relying on operations and IT staff putting in long hours to maintain business as usual in remote locations and deal with multiple IT headaches.

“During this crisis of all crises, the solid foundations of securities services and the robust processing infrastructure have come into their own to support clients in a variety of different situations, being highly solution oriented” adds Ludbrook. Much of this support has been and continues to be provided through a balance of remote working and onsite teams in key hubs.


Enabling pre-trade performance

Yet, for many, says O’Shea, it has highlighted the need for key investments in “areas such as cloud enablement and hosting, APIs for more efficient data distribution, and the related modernisation of core systems”.

“A combination of these components of the securities post-trade value chain is bringing the strength of the franchise to bear as smarter custody solutions provide clients with the services that they feel are most important to them,” concludes Ludbrook. “Going forward, this sustainability in post-trade will result in offering them greater choice with new technologies and data transparency and insights that enable pre-trade performance.”





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