Hedge Funds Face “Perfect Storm” Ahead of UMR 6
Posted by Colin Lambert. Last updated: April 7, 2022
Hedge funds risk being caught in Phase 6 of the Uncleared Margin Rules (UMR) without adequate preparation owing to continued uncertainty over whether they are in scope, a new report from Acuiti has found. Facing a “perfect storm” of increased margin requirements, funds are also being impacted by market volatility, which is forcing them to meet collateral demands through negative steps, such as holding back cash or assets or reducing margin-intensive strategies, that reduce fund performance.
The report, Margin Management for Hedge Funds: An Increasingly Complex Calculation, was commissioned by Cassini Systems, a provider of pre- and post-trade margin and collateral analytics for derivatives market participants, and based on a survey and series of interviews with senior executives from derivatives-focused hedge funds.
The report found that recent market volatility, combined with the upcoming final phase of UMR, has significantly increased initial margin requirements for firms trading all assets, from bilateral to listed and cleared instruments. More than two-thirds of respondents said that margin requirements had increased over the past three years, with a third saying that they had increased significantly.
Overall, the report found that hedge funds are becoming much more sophisticated in how they manage, calculate and process collateral because of the increased margin requirements. Margin is playing a significant role in trading decisions, with 78% of respondents considering margin when deciding where to trade, and 30% having a view of margin impact available at pre-trade. There is, however, still some way to go on the road to margin efficiency, with just 13% aggregating and analysing margin requirements intraday.
The report says this uncertainty of whether firms are in scope for UMR phase 6 or can get themselves under the threshold is creating a significant risk that funds will be caught out late if they do not act now to reduce uncleared exposures or more accurately model and manage their current portfolios.
The new regulations come at a time when margin requirements are rising across the board for hedge funds. The collapse of Archegos Capital Management in March 2021 has led to stricter enforcement of margin policies and, in some instances, increased margin requirements for hedge funds from prime brokers, the report found.
“Hedge funds are facing a perfect storm of factors that are increasing margin requirements and taking actions that impact fund performance to mitigate. Funds are therefore having to become much more sophisticated in how they manage margin and collateral in order to reduce drag and optimise performance,” says Will Mitting, founder of Acuiti. “The uncertainty around UMR is adding to the complexity for hedge funds. Firms looking to spread exposures across different counterparties or temporarily reduce exposures face a significant risk of coming into scope without adequate preparation either in September or further down the line.
“Regardless of UMR, margin optimisation should be seen by funds as a means of boosting efficiency and fund performance,” he adds.
Liam Huxley, CEO, and founder of Cassini, says, “This report makes it crystal clear that hedge funds should be taking urgent steps to implement margin and collateral transparency and resilience across the trade lifecycle. Tools like these can provide a clear picture of current exposures but also enable firms to prepare for future market events while reducing margin exposure and carry cost.”