The coming 12 months will see an upheaval in financial markets as the impact of two important pieces of regulation is felt by more buy side firms.
The Uncleared Margin Rules (UMR) and the Standard Approach for Counterparty Credit Risk (SA-CCR) will have a direct and indirect impact, respectively, on the largest asset managers. Although some managers may still be out of scope of UMR, the trickle-down effect of these regulations on their bank suppliers means they too should be preparing now.
Put simply, capital and margin are getting more expensive for banks. Consequently, the cost of servicing clients in the age of SA-CCR and UMR will increase, sometimes dramatically, if no additional measures are taken. Reducing these effects requires a joint buy- and sell-side effort to maintain an optimal, or even in some cases sustainable, service model for the benefit of all participants. Capital optimization opportunities will be at the heart of solving for this.
There is much to establish on the final impact of SA-CCR, but a significant impact is likely to be in directional, uncollateralized portfolios. For managers who fit this profile one may need to expand the network beyond the bilateral dealer to client and work across the panel of the manager’s counterparties. Finding solutions to address SA-CCR impact clearly has mutual benefits such as maximizing market accessibility and liquidity for the buy-side and opportunities for the sell-side.
An example of how asset managers are likely to be affected can be found in the knock-on effect of the G-SIB (Globally Systemically Important Banks) regulation in the forward FX market. A 2020 White Paper from the Bank for International Settlements found that at quarter-end, when banks are most focused on their G-SIB rating, – and as normal market practice, asset managers also re-evaluate and rebalance portfolios -, there is a discernible reduction in liquidity levels in FX swaps markets and spreads widen.
As the focus on capital efficiency and usage intensifies, it may well transpire that these particular liquidity phenomena don’t appear only at quarter-end, and managers could find their panel of banks less able or willing to price them as aggressively as they once had. Therefore, the starting point for many managers is having conversations with their providers to explore what they mutually could do to help the banks’ positions, and vice versa, and finding technology solutions enabling access to a broad centralized network of participants.
There are naturally multi-fold additional optimization benefits to be had for the buy-side. Such technologies with novation and compression solutions that are tailored across their needs – including the management of counterparty concentration risks, limits, and gross notional levels – further reduce capital costs and increase operational efficiencies.
This means that FX capital optimization is going to become a much more ingrained part of an asset manager’s toolkit, with in-depth analytics and well-presented data that is easy to interpret and action. This further implies a need for technology solutions dedicated to providing managers with the most up-to-date information and the ability to partake in optimization at the click of a button.
Initially, dealer-to-client SA-CCR optimization will likely be more post-trade based, with the manager retaining access to its same panel of liquidity and trades can be re-papered to the most appropriate and capital-effective counterparties. In the future, one can further envision a process where the impact of capital optimization is embedded in FX TCA (Transaction Cost Analysis) for instruments such as FX Forwards and Swaps. Ultimately, capital optimization is one component of many that can be incorporated into best execution processes to manage costs for the benefit of the end investor.
The clock is ticking on UMR and SA-CCR and although the costs on banks have not necessarily cascaded to the buy side so far, their impact is becoming more quantified. This will not be a ‘big bang’ moment since banks sit at different stages of their understanding of SA-CCR’s impact and is yet to be fully assessed. However further down the road, the overall benefits of addressing these capital costs with counterparties will become impossible to ignore.
Dr. Petra Wikstrom holds a PhD in Turbulence, Fluid Dynamics, from the Department of Mechanics at the Royal Institute of Technology (KTH) in Stockholm, Sweden, one of Europe’s leading technical and engineering universities.
Petra is currently a Business Development Executive with Capitolis. She is the former Global Head of Execution & Alpha Solutions within FXLM & Commodity Derivatives Sales and Trading at BNP Paribas in New York, NY. Previously she was the Head of QSI North America within FXEM Sales and Structuring at Morgan Stanley in New York, and the former Global Head Quant Solutions at RBS (now NatWest) in Greenwich CT and London, England.