The coronavirus pandemic has brought increased volatility and uncertainty to the financial markets. As firms respond to the new demands and pressures of today’s environment, they have received welcome relief in one key area: regulation.
A number of new rules were scheduled to go live over the course of 2020 and 2021, but many of these mandates have now been postponed as firms manage through the pandemic and delay pending compliance decisions around processes, policies and infrastructure. Key pieces of regulation include:
Uncleared Margin Rules (UMR), Phases 5 and 6
The Basel Committee on Banking Supervision (BCBS) and the International Organization of Securities Commissions (IOSCO)’s UMR first went live in 2016 and impacted most of the market. However, only a small number of firms were actually impacted by the dual initial margin requirement, which was rolled out in phases. Due to the coronavirus, the implementation of phase 5 and phase 6 have been pushed back one year to September 2021 and September 2022, respectively. In these phases, an estimated 1,000 or more firms – predominantly funds and institutional investors – will be subject to the bilateral exchange of initial margin. While this will help reduce risk to counterparties, it will require firms to acquire new skills and competencies in order to undertake functions they may have never performed before, all of which could lead to increased costs.
Securities Financing Transaction Regulation (SFTR)
While SFTR is European in origin, it will affect US-based firms that have transactions executed in Europe. Implementation will now take place this July (pushed back from April) for broker-dealers, and in October for the buy side. Certain information, such as legal entity identifiers and unique trade identifiers, may be required by dealer counterparties before reporting obligations are phased in. This means that some institutions may need to be ready for an earlier ‘go-live’ date, before the official deadline, to ensure information requirements can be met.
Central Securities Depository Regulation (CSDR)
The incoming Settlement Discipline Regime (SDR), a key component of CSDR, will require investment firms to implement measures to mitigate settlement fails, and while this is also an EU-based regulation, it will impact firms trading with EU organizations or trading in EU-registered securities. SDR requires trades to settle within the mandated T+2 timeframe, and market participants will incur financial penalties and could be subject to expensive buy-ins for those trades that do not settle within this period. As a result, buy-side firms will need to undertake an analysis of the cause of their failed trades and address any post-trade inefficiencies to avoid potential costs. The compliance deadline for this is expected to be pushed to February 2021.
It’s important to note that, in conjunction with complying with these new regulations, financial institutions are also working to prepare for LIBOR transition and Brexit adjustments. We cannot overlook the compounding effect these regulations may have, which can sometimes lead to unintended consequences. For example, many firms are expected to make securities lending a key element of their liquidity management strategies to offset the operational and funding costs of UMR. However, this reliance on securities lending could increase reporting obligations under SFTR and have an adverse impact as firms look to mitigate settlement risk under CSDR. The multiplying effects of these regulatory demands is challenging traditional buy-side operating models and introducing new costs across a range of functions.
It’s undeniable that today’s environment has caused immense uncertainty and greater cost-cutting pressures, and investment management firms may find it difficult to secure the resources needed to upgrade in-house systems or perform major overhauls of current platforms to meet regulatory mandates and to continue to grow their client-service capacity. However, it’s important to recognize that despite the intensity of the current situation, it is nevertheless temporary, and it is critical that firms continue with their preparations to meet regulatory obligations, as doing so will ensure that companies can continue to support their clients in the future. One way firms can do so is to turn to third-party vendors as a more cost-effective way to achieve compliance – especially as regulations continue to evolve.
Needless to say, the second half of 2020 will be a critical time for the financial industry as firms assess the full impact of coronavirus on the economy and prepare for regulatory obligations that are on the horizon.
Tim Keady is chief client officer (CCO) and head of DTCC Solutions. In his role as CCO, Keady leads DTCC’s sales, relationship management, global solution delivery, and marketing and communications functions, which support the company’s global client base and drive increased enterprise-wide client value across all services. As head of DTCC Solutions, he is responsible for overseeing DTCC’s derivatives and collateral, institutional trade processing and data services businesses.