As we leave 2020 behind and start 2021, we find ourselves looking ahead and planning for the new year to come.  For many on the buy-side, that means UMR compliance deadlines.  The 1-year delay from the original September 2020 deadline for phase 5 firms gave us a much needed breather, but as the calendar flips to 2021, those deadlines come quickly back into focus.  We’ve spoken a lot about the high hurdles, both operationally and legally, to achieving UMR compliance.  For a detailed account of those hurdles, a copy of our comprehensive UMR guide can be found here.  But in addition to the operational and legal aspects, the cost aspect of compliance cannot be ignored.

New IM CSAs and custody agreements need to be negotiated, entailing significant legal cost.  New segregated custody accounts need to be opened and maintained, entailing significant additional custodial cost.  The additional collateral requirements will of course come with a cost of sourcing that collateral.  The additional operational burden can have a hefty cost as well, if staff are forced to manually account for all the new operational processes.  While the legal, custodial and collateral costs are likely to be more or less set, the operational cost is one that can be somewhat mitigated through increasing efficiency.  One way to gain some of that efficiency is to enhance existing internal systems to better handle the changing workflows and higher volumes.  Process automation will be key.  But another way to gain that needed efficiency may lie in rethinking the UMR workflow altogether.

Some on the buy-side have already concluded through their own legal review, that they do not have a regulatory requirement to independently calculate regulatory IM (via SIMM, or the Standard Schedule) themselves.  The contention here is that the dealer on the sell-side is doing that calculation, and the buy-side may, if they choose, rely on that calculation rather then accepting the high cost of replicating that calculation themselves.  While the extent to which this complies with regulations may vary by regional jurisdiction (and we would certainly advise you to seek out your own legal opinion before making any decisions), this decision could have a profound impact on the cost of compliance.

Performing an independent SIMM calculation comes with a high cost.  You need to first develop systems and processes for calculating the trade sensitivities that are the inputs to the SIMM model.  If you are not able to calculate those sensitivities, there are services on the market who can do that for you… for a cost.  Then, the cost of SIMM calculation itself needs to be considered.  Finally, once the calculation is done, you can do a daily comparison with your dealer’s number.  And when there is a difference?  A dispute process needs to exist, including a sensitivity reconciliation (another cost) which can be somewhat operationally intensive to monitor and cure.  Adding new manual operational processes reduces the very efficiency that it is so critical to increase!

There is, some would argue, a precedent for relying on a dealer’s calculation for initial margin.  In the Futures world, FCMs have been charging initial margin calculated by a methodology called SPAN for years.  The buy-side generally accepts that SPAN calculation, rarely does the question of replicating the SPAN calc ever come up.  It is just accepted as a cost of doing the trade.  One could argue that SIMM can be viewed very similarly to that.  We believe many on the buy-side may take that view, as taking the approach of not independently calculating SIMM and using your dealer’s calculation instead can lead to a greatly reduced cost burden for UMR compliance.

Still have questions? Give us a call.