FMSB Focuses on Uncleared Margin for OTC Derivatives

The Financial Markets Standards Board has published its latest Spotlight Review, this time looking at uncleared margin for OTC derivatives, an area that is still complex and in need for greater efficiency according to the standards setting body.

FMSB says the review illustrates the impact of key frictions and support for potential solutions in greater detail than has been before. This highlights, it adds, the most valuable areas of potential future work to improve the operational efficiency for the calculation and exchange of uncleared margin; notably, the collateral required to be exchanged between counterparties to cover their exposure to each other’s OTC derivative trades.

The Bank of England’s Post-Trade Task Force initially highlighted inefficiencies in the processes for exchanging uncleared margin, including high settlement fails and costs in its Report: Charting the future of Post-Trade. Subsequently, FMSB’s Post-Trade Committee formed a working group to further explore the issues and, noting that differences in opinion, or perceived differences of opinion, were holding back industry efforts on many of the identified frictions, responded by designing and conducting a survey of member firms to illuminate the extent of agreement on a range of problems and their potential solutions.

The results of working group meetings and survey are summarised in the Spotlight Review, FMSB says, noting that while the frictions identified were largely expected, there was surprise as to the scale of some – for example, SSI-related issues dominated the causes of settlement fails. “This is a non-product specific problem, with established solutions,” FMSB states.

FMSB also notes that the survey demonstrates that certain parts of the trade cycle, in particular the margin call process, are already mature, and/or have causes for and solutions to frictions that are fragmented, leading to low marginal gains for the effort expended to tackle the residual. The review notes that a level of non-standardisation is to be expected in a bespoke market such as OTC derivative markets – for example, the desire to maintain autonomy over valuation models and inputs.

Reducing the time taken to determine the cause of disputes, however, was identified as a key area of opportunity for improvement, with both workflow improvements and the use of new technology noted as potential future initiatives. Additionally, in other areas, the FMSB member survey identified solutions which can be unilaterally applied by firms now, or negotiated with individual clients, as well as extensive, and in some cases unanimous, support for other initiatives that would require widespread market adoption for success.

“Today’s Spotlight Review delves deeply into the operational frictions and inefficiencies of uncleared margin, offering unprecedented detail,” says Warren Rees, global business product owner & transformation lead at JP Morgan and chair of working group. “It highlights widespread support for practical solutions to help solve some of these issues, overcoming past misconceptions preventing adoption. Firms are now urged to collectively adopt these solutions to enhance and automate OTC derivative collateral lifecycle processes for all stakeholders.

As a Working Group, we will (in partnership with ISDA) also explore ways to encourage adoption and develop solutions in areas needing further support such as onboarding, disputes and settlement,” he continues. “I am grateful to the hard work and close collaboration of both working group members and FMSB members for their invaluable contributions to our survey, which illuminates paths to process improvement.”

Scott O’Malia, CEO of the International Swaps and Derivatives Association (ISDA), adds,

“ISDA welcomes the work of the Financial Markets Standards Board to support post-trade efficiencies, including margin calculation and communication, collateral settlement and portfolio reconciliation processes. Streamlining these workflows will further mitigate operational, counterparty and liquidity risks, supporting safe and efficient markets.”