The buy side is facing a paradigm-shifting year in 2022 as both the Uncleared Margin Rules (UMR) and SA-CCR (Standard Approach for Counterparty Credit Risk) increasingly impact financial institutions globally. As we highlighted in Why the Buyside Should be Talking to Banks About Capital Costs, there are solutions at hand for investors and managers to mitigate both direct and indirect effects on capital costs. What’s more, the crucial factor in achieving sizeable cost savings is easily accessible data, coupled with systems integration.
To grasp the magnitude of the new regulatory changes, in the UK and US alone, which make up some 60% of global FX turnover, non-bank financial institutions traded $570 billion per day in outright forwards, including Non-Deliverable Forwards and FX swaps. These products -in addition to options and other products across asset classes- are all subject to SA-CCR.
On top of this, the new standardized approach is different to previous capital regimes because exposures can be netted by currency pair, and do not need to be of the same tenor. The good news is that banks can now net a one-week trade against a five-year trade. On the flipside, asset managers’ rolls of positions, especially at month-end, can be large and directional. If a manager is rolling a $2 billion position for one month, this FX swap, if margined, will now attract the same regulatory costs as a six-month swap.
Beyond SA-CCR, UMR is now entering phase 6 in September 2022, and for funds entering the in-scope status, much of the reporting and systems integration is ongoing, further adding to regulatory complexity.
Banks globally have been actively utilizing capital optimization for cost savings, especially since the financial crisis. While take up on the buy-side has been more niched, it is now increasing across managers with a broader range of recognized benefits. One core driver is that capital costs are becoming more transparent and measurable with increased access to data, automation, and technology. This path is similar to what we saw with increased adoption of automated execution on the back of regulatory reforms for Best Execution.
Easy Data access:
Like all change, the implementation of new regulations bring uncertainty that needs to be worked through. Doing this in a manual setting is both time-consuming and suboptimal in terms of results. Tools, networks and leveraged learning can help facilitate and ease the transition. When a manager can easily access and view all their exposures in one place and submit their funds’ data for analysis and processing in an automated manner – the cost savings are maximized.
The need for seamless data connectivity has been an ongoing theme across the financial industry with companies leveraging external technologies to solve for internal needs. This is achieved by connecting pre-/post-trade systems through API and Cloud services with technology engines. At present, banks are actively optimizing to achieve significant SA-CCR savings in a multilateral interbank setting. This has accelerated efforts to streamline data systems and integrate effectively with technology service providers.
Correspondingly, there is a need for investors’ and managers’ data to be easily accessible in a dealer-to-client automated workflow. Managers need the ability to look at their entire portfolio of trades across funds, and counterparties, with their respective constraints identified (for example, the non-commingling of trades across investment strategies). The more comprehensive the data, the more opportunities for optimization and cost savings exist. Secure, direct connectivity between managers’ data and third-party optimization engines, adds another level of efficiency to the process as it allows managers to integrate seamlessly with technology providers from their own systems.
Bringing it all together:
Given the importance of data and connectivity, Capitolis is facilitating the integration with a range of systems, and recently entered a partnership with TradeNeXus which provides direct data access and compression optimization and analytics to its users. This results in seamless access to identify optimization, to eliminate large and unnecessary positions and to free up capital. Similarly, Capitolis recently entered a partnership with Acadia to process and generate a series of FX transactions that reduce capital requirements for banks and other financial institutions.
The direct benefits of capital optimization are broad and can include reductions in gross notional, line items, and counterparty concentration risk. It also provides margin efficiencies, frees up limits and addresses overall operational risks. Further benefits are achieved when the investor or manager takes part in an optimization framework that is also reducing the SA-CCR induced capital costs their counterparties carry from their mutual exposures.
To excel with capital optimization, managers need a consistent solution that works across participants, in a centralized network. Since managers’ numerous counterparties will be on the same schedule, there are also network effect benefits from broad participation. Client to dealer optimization has become a multilateral process in the age of SA-CCR.
 Semi Annual FX Turnover Report, April 2021, UK FX Joint Standing Committee (JSC) and New York Foreign Exchange Committee (FXC)
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.