The impact of margin requirements for non-cleared OTC derivatives on the fund management industry
The new rules on the margining of non-cleared OTC derivatives have yet to be finalised. Yet a four year transition to the new rules begins on 1 September this year - a date less than nine months away. Which means fund managers that use non-cleared OTC derivatives have an extremely narrow window in which to ensure they have the skilled people, technology platforms, margin calculation and collateral management systems, operational procedures, and revised documentation in place to comply with the new rules.
To help fund managers understand what is required of them, and how prepared they are by comparison with their peers, the Depository Trust & Clearing Corporation (DTCC) has published an analysis of the results of a survey it conducted in the closing months of last year.
The key findings of the White Paper are:
- The use of non-cleared OTC derivatives is widespread, and not confined to the largest managers, or particular investment strategies;
- A tiny minority of fund managers, one in eight, claimed in the survey to be completely ready for the coming into effect of the new rules;
- Many managers continue to rely on manual procedures to source and move collateral, which will be overwhelmed by the coming speed and volume of margin calls;
- Managers will have to review and re-write dozens or even hundreds of Credit Support Annexes (CSAs) which document existing relationships with counterparties;
- Many managers will for the first time have to post Initial as well as Variation Margin to their counterparties, creating a significant operational challenge;
- The requirement to post cash as margin will damage investment performance by forcing managers to hold more cash, or incur the costs of raising it in the repo market;
- Collateralisation of transactions across currency barriers will attract punitive haircuts, forcing managers to incur excessive costs in the foreign exchange markets;
- Only a minority of managers declared themselves ready and able to calculate the gross notional exposures and initial margin payments required by the new rules; and
- The systems and procedures followed by fund managers active in multiple jurisdictions will have to be adapted to cope with variations in the local application of the rules.
“At the DTCC we have been monitoring the likely impact of the new rules on the margining of non-cleared derivatives for some time,” says Paul Quarto, director of product management and professional services, collateral management group, DTCC. “Our survey and white paper documents wide variations between managers in their level of preparedness for this new regime. While the initial thresholds for compliance look high, and the transition to the new rules will last for the next four years, the resources needed to comply, in terms of people, systems, processes and procedures, and documentation, are substantial. Our advice to fund managers is not to waste any time in starting work on this challenge.” The ProtoColl system, owned and operated by DTCC, is used by fund managers, fund administrators, and investment banks to automate the margin call process for both cleared and non-cleared OTC derivatives. The system is currently being upgraded to help fund managers cope more easily with the margining of non-cleared OTC derivatives.