By Peter Rippon, CEO, OpenGamma.
New regulation introduced to mitigate the systemic risk associated with both cleared and uncleared OTC derivatives has also brought about additional costs and challenges for firms trading these products. The preparatory difficulties are clear: lengthy negotiation of legal documentation, custodian selection, margin calculation models and collateral mobilisation. However, there are much bigger challenges that will present themselves further down the line once these rules kick in. Firms do have an opportunity to adapt to the longer term impact of new regulation, and those that do will to achieve competitive advantage.
Dramatically lower portfolio liquidity
More liquid assets are now required to be posted as collateral for derivatives positions under new regulation, sucking liquidity out of firms. This results in more assets having to be held in lower yielding securities and low yielding cash. As a result, this has magnified the importance of actively managing portfolio liquidity, especially so in periods of higher market volatility.
Visibility into the impact of new rules on portfolio liquidity is now available through advanced analytics which can forecast the future margin requirements. Big-data paired with smart analytics can support the tricky new balancing act involved in maintaining liquidity while minimising the drag on returns.
Significantly more operational exposure
With the increase in the number of margin calls – and subsequent increase in complexity surrounding them – the probability of incorrect calls has increased dramatically. Posting excess margin is, firstly, highly inefficient from a cost perspective. Plus, there is an inflated operational risk from failing to ensure that the right amount of investor assets are being posted as margin.
However, technology is available to minimise the new risks inherent in this process. Through replicating the complex margining models, firms are able to validate margin calls and mitigate operational risk created under the new rules.
To sum up
With Phase V of UMR being moved back from September 2020 to September 2021, firms really should be using this time as an opportunity to look beyond only the ‘must have’ operational requirements to the longer term impact that these rules will have on both return and liquidity.
The reason the delay was agreed upon was due to the struggle firms were finding in meeting the original deadline, so it is imperative that – rather than resting easy – firms use the extension to prepare themselves for the less obvious longer term impacts of these regulations. •
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