Asset Managers Face Surging Costs Under New Derivatives Rules
(Bloomberg) -- Asset managers are about to see trading costs surge under new rules meant to reduce risk in the $15.8 trillion derivatives market.
Hedge funds, money managers and insurers with more than the equivalent of $59 billion of uncleared derivatives will have to post more collateral under the penultimate phase of post-crisis regulations that took effect this week.
Group-of-20 leaders decided after the financial crisis to push trading of over-the-counter derivatives through clearinghouses where possible to reduce systemic risk in case of default. The risks from uncleared derivatives were underscored again this year by the implosion of Archegos Capital Management, which accumulated leverage through contracts that are traded off exchanges.
“The new rules will undoubtedly create new challenges and increase costs for asset managers,” said Dimitri Tsopanakos, head of Deloitte’s investment management and wealth risk advisory practice. “Analytics and smarter methodologies, especially at pre-trade level, will be needed.”
Read More: Wall Street Swap Traders Get Break on Margin Rules During Virus
Uncleared margin rules have been implemented in phases since 2016, starting with the biggest banks. The current stage was delayed from last year because of the Covid-19 pandemic, and the final step in September 2022 will capture firms holding 8 billion euros of derivatives, according to the Basel Committee on Banking Supervision and the International Organization of Securities Commissions.
The rule change was a “huge compliance challenge,” forcing firms to renegotiate documents and introduce new systems, said Scott O’Malia, chief executive of the International Swaps and Derivatives Association. The reforms “will bring hundreds of smaller banks, asset managers and pension funds into scope, far more than the number of firms caught by the first four phases combined,” he said.
The new rules will make portfolio management more cumbersome, but may also lead to creative solutions.
Firms will need to build models to determine the size of their portfolios, decide whether they can bring them below the threshold and develop mechanisms to exchange collateral, said Joe Kohler, partner at law firm Reed Smith.
Peter Rippon, chief executive officer at technology provider OpenGamma, said funds may be encouraged to build internal systems and teams that put their balance sheet to work more effectively.
“This is the first time that asset managers are really feeling the crunch of having to tie up more of their assets as collateral,” Rippon said. “Banks have been doing this for years, but for asset managers this is the trigger point.”
Companies may alter their trading styles to reduce costs around affected products, such as equity swaps, uncleared swaptions and foreign-exchange non-deliverable forwards. They may also shift to standardized trades, creating opportunities for clearinghouses.
“Locking up initial margin may prompt managers to question whether a derivative continues to be the right way to achieve the objective they desire,” said Deepak Sitlani, a partner at Linklaters.
At the end of 2020, the biggest banks collected $129 billion of initial margin for non-cleared derivatives deals from their counterparties within the scope of the rules, according to ISDA.
In a sign of increased efforts to avoid higher capital charges, asset managers’ notional positions at CME Group Inc. surged to a record $145 billion in August from $59 billion in 2017.
What Bloomberg Intelligence Says:
“The next phase of the uncleared margin rules incentivize the use of central-clearing platforms to reduce margin and operational costs. Regulations are designed to reduce the use of bilateral over-the-counter derivative transactions, a vast majority of which have now been centrally cleared.”
-- Ira F Jersey, Chief US Interest Rate Strategist
Whereas credit investors started voluntarily clearing some individual contracts to boost liquidity, other markets have remained largely bilateral. Weekly swaps reports published by the Commodity Futures Trading Commission show that just over 2% of the FX derivatives market is centrally cleared.
Market participants could reduce their exposure to the rules by trading in listed options, according to Paul Houston, global head of foreign-exchange products at CME.
Posting margin “involves setting up ISDA agreements and implementing operational and collateral management processes. It’s quite a big undertaking,” Houston said in an interview. “If they can substitute some of their forward activity with listed foreign-exchange futures they can get below the threshold.”
©2021 Bloomberg L.P.