The implications of SIMM on liquidity and funding
Tracey Adams of Lombard Risk examines examples of three challenges faced by market participants caught up on the first wave of SIMMIn September 2013, the Working Group on Margin Requirements (WGMR), a group mutually run by the Basel Committee on Banking Supervision (BCBS) and the International Organization of Securities Commissions (IOSCO), issued a final margin policy framework for non-cleared, bilateral derivatives. A key component of the WGMR implementation programme is the Standard Initial Margin Model (SIMM) project, which is focused on developing a common initial margin methodology that can be used by market participants globally.
While the industry has talked conceptually around SIMM for the last three years (indeed, it has been a topic that has consumed conferences and forums), it has only been since 1 September 2016, when SIMM went live for the largest derivatives users, that it has really shaken institutions into action. So, in a world where we have become so used to the regulatory environment, to the point of fatigue, why has the International Swaps and Derivatives Association’s (ISDA) SIMM caused so much of a flutter? More importantly, why and how is SIMM encroaching onto the processes and capacity of the securities lending environment?
As highlighted in Figure 1 overleaf, more jurisdictions are expected to adopt the SIMM model. This article provides context around examples of three challenges faced by market participants caught up on the first wave of SIMM. There is little doubt that additional entities will be phased into the margin rules over the next four years. Fortunately, we now have insight into the challenges faced by the first wave of institutions and therefore guidance on what those firms, that are yet to be affected, need to be mindful of. One further side note—while we have insight into the experiences of sell-side firms, we must not forget that buy-side firms will also face the same challenges in acquiring SIMM calculations.
Integration and funding
The reality is that most firms will need to adapt or replace existing solutions to support SIMM. Some firms may have initial margin calculators, however, very few will meet the complexity of the SIMM model, be centralised across desks or fully integrated into collateral management systems and optimisation units. In order to limit the liquidity drain that SIMM will create, firms must implement dynamic aggregation rules across multiple products, calculate initial margin at the group level and the cost allocation at the entity level. This detail must be carried out across multiple agreements, be quick to calculate, consider multiple factors and have the ability to run historical analysis based on previous activity.
Based on industry feedback, one of the first challenges on 1 September 2016 was the ability to combine SIMM with other pre-funding requirements across business lines. Another constraint was the ability to perform a calculation that considers other funding requirements such as the overall cost of collateral (which will again increase) and available inventory. This is the reality when calculating the cost of collateral on initial margin. For example, the calculation must consider cost complexity of future exposure. In addition, firms may have to go down to the granular detail of reallocating collateral costs on a trade by trade basis if they are to assess the true profitability of each transaction. In short, the SIMM calculation should only be considered as one part of the wider puzzle.
Another key challenge around the initial margin calculation that ISDA set out presumes that a consolidated view of all trades and all trade economics are in one central location. While some of the larger firms lifted the lid on data prior to the September deadline, with specific projects focused around data standards, formatting, repositories and flow (mainly for the purposes of European Market Infrastructure Regulation trade reporting and the Securities Financing Transactions Regulation), many project managers will openly admit that data is extremely problematic and that only the surface of the data problem was resolved.
In reality, firms operate on multiple platforms and trading books and data components are often blocked from systems to alleviate latency. Data has now become an issue across desks, agnostic of whether it is for trading or calculation purposes or, in fact, whether it is an equity, a repo or a derivatives trade. What is required is a central repository of data, across assets, which can be called upon for any purpose and at any point in time. This will ensure consistent data standards are maintained without the data itself being a drain on over performance.
The processing of SIMM will bear two significant areas on cost and funding; firstly, around the logic that initial margin must be gross/two-way and also around the potential for increases in disputes based on calculations. The impact of two-way gross initial margining will result in many over-the-counter market participants making significant investments in their funding infrastructures and capabilities.
In an environment where we already experience difficulties around access to high-quality liquid assets and the settlement of collateral, adding initial margin at agreement level, per credit support annex (CSA), will lead to changes in the way in which desks are set up to borrow and lend. Disparate systems, lack of centralised funding desks and inventories that are placed in product silos will all lead to increases in cost.
In terms of disputes, ISDA has stated that it will regularly publish essential risk factors for the calculation of SIMM. Being able to import these factors, including dynamic risk weights and correlations as well as what-if scenarios, will be crucial to not falling into a dispute pit. What’s more, while ISDA’s SIMM aims to reduce the number of disputes by standardising the model used to compute initial margin, the fact that firms still have the option to use internal pricing models to generate the trade sensitivities may also result in a backlog of disputes that will stretch collateral management departments.
With all of the above being said, there has been an increased focus and interest in the utilisation of vendor platforms, such as Lombard Risk’s Colline, which are cross-product in nature, to manage the SIMM process. The question becomes not necessarily one of ‘if a firm has the expertise within it to capture the methodology or perform the mathematics’—SIMM shouldn’t pose any major mathematical or configuration challenges. What adds the complexity (and therefore the cost and capacity) are all the other components that that fit around the model—the data, the hooks into upstream and downstream systems, the linkages with optimisation tools, the automation and the reporting.
There is an acknowledgement from firms that went live on 1 September that SIMM has yet to be looked at in its granular detail. It must fit into their wider ecosystem—an ecosystem that branches out far beyond that of ‘bilateral’ collateral and across into the world of securities finance and repo.
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