Uncleared Margin Regulation (UMR) Margin Requirements for Non-centrally Cleared Derivatives – BCBS 261 Speakers

Gurpreet Chhatwal,

Kshitij Bhatia,

Global Head of Risk & Analytics, CRISIL Global Research & Analytics

Director, Risk and Analytics, CRISIL Global Research & Analytics

December 2015

CRISIL GR&A Summary Global Leader in the Research & Analytics Space

 25-year track record  Pioneered Global Research & Analytics  Team of more than 2,300 analysts

 Serve 15 of the top 20 global investment banks  Serve 2 of the top 10 global consulting groups  Serve 3 of the top 15 global insurance companies

Regulated Entity with Strong Compliance Culture

 Regulated by SEBI, an SECequivalent  The only regulated entity in this space

 Highest standards pertaining to regulatory requirements, compliance, and confidentiality

High Quality Skill Sets

Rigorous & Scalable Processes

Unmatched Financial Business Strength

 Recognized for high-quality service – Our tagline, “The best people to work with” is a verbatim reproduction of what a client said in a survey  Highly experienced and stable management team to ensure high-touch engagement  Large talent pool comprising MBAs/CAs/CFA/FRMs/PhDs and other university graduates  Strong project management capabilities  Quality Assurance and Governance  Information Security

 Robust training programmes  Business Continuity  Inbuilt processes and tools to enhance productivity

 Well-diversified business  Strong balance sheet and zero debt  Market reputation and global reach

 30% CAGR over the past 10 years  Consistent growth across business cycles that provides stability to deliver high-quality services to our clients

Awards & Recognitions

NASSCOM® Exemplary Talent Awards: 2012 (The Talent Magnets), 2011(Skill Enhancement Initiatives)

'Top Green IT Enterprise Award 2012' from CIO Magazine

'Best Leadership Training Programme' award hosted by World HRD Congress, 2012

Roopa Kudva named one of the 20 most powerful women in Business by Fortune India in 2011

Roopa Kudva named one of the 30 most powerful women in Indian business by Business Today magazine, for the third time 2009-2011

Mumbai Corporate office - LEED certified “GREEN BUILDING" 2010

Partnerships with Expert Networks

CRISIL GR&A joined the FINCAD Alliance Program to leverage various FINCAD Analytics that meet the derivatives and fixed income needs of clients. FINCAD is the market leader for innovative derivatives solutions.

Top Research Outsourcer for Financial Services Industry Analytics, 2006, 2007 and 2009

2

Overview of BCBS 261  BCBS 261 aims to promote central clearing and reduce systemic counterparty risks through stringent margin requirements Objective & Scope

 Covers all non-cleared OTC derivatives, except physically settled FX forwards and swaps  Firms are required to exchange the initial margin and variation margin, reflecting the potential future exposure and current exposure, respectively

Initial Margin

Margin

Variation Margin

 Mandatory exchange of two-way gross initial margin

 Bilateral exchange on a regular basis

 Threshold up to €50 million

 Threshold reduced to zero

 Applicable in a phased manner for firms with over €3 trillion exposure by Sep 2016 to €8 billion by Sep 2020

 Applicable for firms with over €3 trillion from Sep 2016 and the rest from Mar 2017

 Push towards highly-liquid collateral Collateral

 Ensure availability and protection through collateral segregation and restricting hypothecation

3

Initial Margin Calculation

Schedule-based



Based on notional amounts



Predefined margin rates as specified by regulators, depending on asset class and tenor

Risk Model-based 

One-tailed 99% confidence interval over 10-day liquidation horizon



Should be approved by appropriate supervisory authorities

Internal Model

Standard Initial Margin Model (SIMM)



Portfolio valuation changes: Firms can use full revaluation or risk sensitivities



Risk modeling: Firms are free to choose how risk is summarized – Value-at-Risk, Expected Shortfall etc.



Risk sensitivity-based initial margin



Common risk factor weights and correlation parameters

Capital Efficiency

Operational Efficiency

Capital Efficiency

Operational Efficiency

Capital Efficiency

Operational Efficiency

ISDA-SIMM is the preferred approach as it reduces operational burden and avoids punitive schedule-based margins

4

SIMM Explained Standard Initial Margin Model

Data Sources

External Sources

1

SIMM Utility

 

Risk Sensitivity Calculation

Calculate sensitivities to each risk factor*

2

Asset Class IM

Calculate Delta, Vega and Curvature margins

GIRR & FX:

Risk weights Correlations

10 yield vertices for each CCY yield curve

3

Total IM

Aggregate IM for GIRR and FX asset classes using correlation of 27%

Apply appropriate risk weights to risk sensitivities

CS (Qualifying):

Data Processing

Internal Sources

Consolidated Risk Database

12 buckets based on credit quality and sector CS (Non-qualifying): 6 buckets based on credit quality and sector Equity:

Risk sensitivities • Risk types • Risk factors

Within risk buckets using intra-bucket correlations

Across risk buckets using cross-bucket correlations

Calculate SIMM as sum of IM for all asset classes

11 buckets based on market cap, region and sector IM (x) = Commodity: 16 buckets

Delta Margin + Vega Margin + Curvature Margin

* FDIC version allows risk offsets based on asset class bucketing only and not risk factors based bucketing suggested by SIMM

5

UMR Implementation Gathering Pace Banks are preparing to meet the minimum requirements amid regulatory uncertainty and lack of industrylevel standards Applicable notional threshold

Particulars

> € 3.0 trillion

Variation Margin Applicable from

1-Sep-16

Initial Margin Applicable from

1-Sep-16

> € 2.25 trillion

> € 1.5 trillion

> € 0.75 trillion

>€8 billion

1-Mar-17

Applicability

1-Sep-17

1-Sep-18

1-Sep-19

1-Sep-20

Risk Data Aggregation Initial Margin Model Development Enhancement of collateral operations system to incorporate UMR terms Building Blocks

Enhancement of portfolio reconciliation architecture to include Risk Sensitivities Reconciliation CSA Renegotiation & updates to ISDA system Client Onboarding & updates to operations system Risk Sensitivities Reconciliation Process Portfolio Reconciliation Team including Risk Reconciliation

Team Ramp up

Margin management Team

Dispute Resolution Team

On track

In progress

Yet to start

6

UMR: Key Challenges for Banks

 Lack of centralized risk repository to provide agreementlevel risk information further grouped at asset class and risk factor level

Process

 Collateral operations system to be enhanced to include UMRspecific fields

 Lack of consistency in calculation methodology of risk sensitivities to increase potential IM disputes

 Dependency on portfolio reconciliation and material term reconciliation process

Fragmented Risk Infrastructure

Data Quality and New taxonomies for risk measures

Lack of Industry Standardization

Resource Augmentation

Data

 Need to set up an initial margin calculation model

 Data sourcing, integrity and accuracy of risk data, completeness, timeliness and adaptability  Data feed management in portfolio reconciliation process and margin management process  Data capture from ISDA/CSA document into ISDA system

 Lack of resources to handle increased volume and complexity in margin management

People

System

Fragmented infrastructure and increased operational complexity & volumes would be the key challenges banks are expected to face

 Renegotiating CSA to incorporate UMR-specific clauses  Significant efforts required to onboard and set up counterparty IA accounts

7

UMR Implementation Framework

UMR

CSA

INFRASTRUCTURE

RENEGOTIATION

UMR / RISK SENSITIVITIES RECONCILIATION

MARGIN MANAGEMENT

8

UMR Infrastructure: Building Blocks

Consolidated Risk Database

Initial Margin Model Building



Consolidated Risk sensitivities information at asset class and risk factor levels is a critical input for IM calculation



The key would be creation of Golden Risk Data Repository including key data elements in the form of data dictionaries and taxonomies



This can be further leveraged for BCBS 239 – Risk data aggregation requirements



Firms to build internal margin models, in line with SIMM to reduce operational burden and avoid punitive schedule-based margins



Initial model to source inputs as explained in SIMM overview ‒ Risk sensitivities from consolidated risk database ‒ Risk weights and correlations from SIMM Utility

Enhancement to Collateral Operations Systems



Banks are required to make significant changes to their collateral management infrastructure to effectively handle increase in volumes and complexity of margin management



Enhancements to ISDA/CSA system and collateral operations systems to be made to include UMR-specific terms

9

Centralized Risk Repository 

Set up a centralized Golden Risk Data repository that would source, clean, reconcile, and maintain risk data



Risk data aggregation should support data lineage, i.e., enable the tracking of source data from an aggregated risk metric

Data Sources

Risk System

Data Storage 

Centralized Risk Repository

Downstream Systems



Create a master database Collate data elements in the form of data dictionaries and taxonomies

Margin Calculation

Counterparty Management System

Trade Repositories

Data Quality 

Data definitions and validations



Filtering and grouping of data

ISDA Management System

Data Standardization

Data Controls



Enable migration to standard risk taxonomy





Provide a common standard reference point for data alignment

Exception reporting of data and to resolve data-related issues



Ensure the integrity of key risk data elements

RWA Calculation

Reconciliation & Dispute Resolution

10

CSA Renegotiation and Margin Management CSA Renegotiation 

Documentation and data capture in ISDA management system ‒ Re-negotiations of CSA to include IA-specific clauses would involve significant volume in re-drafting agreements and incorporating the same in the ISDA management system



ISDA /CSA reviews would be critical to ensure accuracy of ISDA document management system

Margin Management 

Scope and coverage of margin call volumes to increase ‒ Firms are likely to make multiple currency-variation margin calls to match collateral currency with settlement currency, and thereby, reduce leverage ratios ‒ Volumes are expected to increase multifold, hence the need for scaling up operations proportionately to achieve compliance



Collateral segregation is expected to introduce complexities in margin management process



Significant effort will be required to onboard and set up one-time individual counterparty IA accounts

Resource augmentation and process automation critical for handling increased operational complexity and volumes

11

UMR / Risk Sensitivities Reconciliation UMR Reconciliation Engine

1

UMR / Risk Sensitivities Reconciliation

Model Differences

2

Static Data Mismatch

3

Risk Factor Mismatch

Rule Based Analysis

Internal Issues

Counterparty Issues

4

Risk Measure Mismatch

Incremental Analysis

 Internal exception reporting tools

Internal Issues

 Automated tags on known CP issues to the trades

 Independent pricing  Mimic CP risk in internal systems

Counterparty Issues

 Deep dive analysis

Break-flow Management Tool

Internal Stakeholders

Counterparty

UMR Reconciliation Engine

12

Changing Face of Collateral Management UMR to redefine the scope and increase the complexity of Collateral Management

Risk Management System

Consolidated Risk Database Trade level Risk Sensitivities

IM Calculation Engine

ISDA Management System

Portfolio Level IM

Collateral Operations System

Portfolio Reconciliation System

Collateral Ops Team / Margin Management Team

Margin Calls

Pledge & Segregation

Fails & Reconciliation

Portfolio Reconciliation Team

Material-term Reconciliation

Valuation Reconciliation

Risk Sensitivities Reconciliation

Dispute Resolution

Counter Party UMR additions

13

www.crisil.com/gra

Stay Connected

|

Twitter |

LinkedIn |

YouTube |

Facebook