The implementation of UMR represented one of the most significant changes in market history.
The UMR journey along the Collateral Highway
Uncleared Margin Rules (UMR) were a regulatory response to the global financial crisis with the twin aims of minimising systemic risk and promoting centralised clearing in the Over-The-Counter traded Derivatives (OTCD) market.
Although UMR is primarily focused on the derivatives market, it has had a significant impact on the use of collateral globally, affecting the entire Collateral Highway® community. This made the Euroclear response both complex and challenging - requiring thought leadership and innovative solutions.
We are proud to say the Collateral Highway has now completed the UMR transition from a market initiative to business as usual: serving the current and future needs of the collateral community.
When UMR was first proposed, regulators assumed that having 5 separate waves would equate to a gradual, phased process that would see it expand in fairly equal increments, starting with the largest firms in Phase 1. However, the Standard Initial Margin Model (SIMM) requirements asked for a lot more than just a simple initial margin exchange. The whole market needed to decide on the best way forward.
Euroclear took a leading role, providing our flexibility, creativity and innovation to build a model fit for purpose and in compliance with the regulations. Our vision was that triparty, with its cross-optimisation of collateral, together with the robustness of the adapted account type and legal structure, could be advantageous for clients and the optimal solution.
The market realised that the volume of daily margin calls required couldn’t be achieved manually and that Straight Through Processing (STP) throughout the process would be the only viable way forward and looked at Euroclear to provide a solution within its triparty framework. Working with the International Swaps and Derivates Association (ISDA) and integrating our proposal account and legal structure into ISDA framework agreements, more and more key clients opted for the Euroclear Bank triparty solution.
With Phase 1 specifically impacting the largest OTCD counterparties, the size of their exposures led to massive volumes. To make sure we could help as many clients as possible meet the regulatory deadline, we started with High Quality Liquid Assets (HQLA) collateral profiles, expanding to more complex baskets at a later stage.
Only a small number of additional firms came into scope in UMR phase 2. Following several industry interactions through seminars, webinars and individual client visits to outline the Euroclear admission, set-up procedure and project plans, the robustness and efficiency of the Euroclear solutions were re-confirmed and recognised by the market. As with Phase 1, the Euroclear triparty STP solution was embraced as the optimal solution, especially for the large volume of transactions between dealers that had previously been unsecured exposures, and now became secured and subject to margin requirements in Phase 2.
Phase 3 is when new buy-side client segments, in particular hedge funds, came into the scope of the regulation. Many were new to International Central Securities Depositories (ICSDs), triparty and their respective setups, so a new approach was needed.
The Pledgee Representative model was introduced. This allows one party to collect Initial Margin (IM) on behalf of underlying clients. Initially foreseen as a method for custodians to keep their direct client relationships (rather than those underlying clients becoming direct Euroclear Bank clients), this model was also favoured by grouped entities as one of the group entities could act as Pledgee Representative for other entities within the same group.
The Pledgee Representative model created new business opportunities for representatives while it massively simplified the setup for underlying pledgees.
A new account type was also created: the MultiSeg account. Here, only one pledgee account is needed to collect all IM across multiple different pledgors, while maintaining collateral segregation and robustness over eventual insolvencies.
Having only one single receiver account massively simplified the IT and operational setup, for both us and our clients, while guaranteeing collateral segregation of all pledgors and maintaining clear and transparent insolvency procedures.
Phase 4 marked a significant change as the number of buy-side firms (also as pledgors) coming into scope increased dramatically.
Euroclear brought the main custodian firms together into a new forum, the Custodian Advisory Group (CAG). For more than a year, the CAG met regularly to discuss how to address industry concerns and find constructive solutions.
The CAG eventually led to the introduction of the Collateral Portfolio Model. Here we perform triparty collateral management calculations and return the amended file, showing the triparty collateral allocations, ready for settlement on the books of the custodian in favour of the respective pledgees. This allows custodians to keep their client relationships while exchanging a file of available collateral with Euroclear.
For Phase 4, we also created the new UMR Restricted Admission option. This offers clients that only want to use our UMR Pledgee service, a leaner and quicker admission process - requiring less effort than a full admission. UMR Restricted Admission proved to be a very successful way of accessing Euroclear with more than 50% of UMR-related admissions being ‘restricted’.
The initial challenge to Phase 5 was estimating just how many buy-side counterparties would come into scope. Industry estimations ranged between 1,000 and 10,000. Add to that the ongoing pandemic and resulting pressure on resources - regulators had little choice but to postpone the official start of Phase 5 by one year, to September 2021.
It soon became clear that we were looking at setting up a dramatically larger number of counterparties in Phase 5 than in previous phases. Both Euroclear and ISDA urged impacted parties to get started as soon as possible. Despite this, the challenges for the market remained significant and many struggled to meet the set-up requirements in time.
To minimise further delays, we re-organised and pulled resources from across the group to manage set-up requests and onboard these new clients using the UMR Restricted Admission developed during Phase 4.
Following the very turbulent, albeit ultimately successful, Phase 5, and the significant inflow of collateral, we continued connecting seamlessly with the market through regular client consultations and webinars to assess the planning needs for Phase 6.
Based on our shared collective experiences, we developed a new approach for Phase 6 with monthly onboarding batches starting as early as January 2022 and continuing beyond the official Phase 6 start date in September 2022.
With these monthly onboarding slots, clients had only two deadlines to respect which massively simplified their administrative and operational workload.
The total UMR collateral outstanding has now reached more than EUR 140 billion, and continues to grow.
Although many of these innovations stemmed from UMR, they paved the way for further improvement of the Collateral Highway client experience way beyond UMR.
Restricted admissions can be adapted for other Euroclear Bank services. MultiSeg account structure and Collateral Portfolio Model can be of use for equity collateral together with the now well-known and proven pledge structure.
All UMR phases have now been implemented in Euroclear Bank. UMR business is a proven, stable and efficient element of the Collateral Highway. This is why we can now consider it as being business as usual, benefiting both UMR clients and the wider Collateral Highway community.
