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With Phases 5 and 6 of the Uncleared Margin Rules (UMR) becoming effective in September 2021 and 2022, respectively, it is interesting to look at the impact this will have on fixed income as an asset class. We asked Phillip Simons, Global Head of Fixed Income Sales, Derivatives, Funding and Financing at Eurex Clearing, to provide us with some valuable insight.
Phil, how is fixed income as an asset affected by UMR phase 5&6?
Phases 5 and 6 of UMR will predominantly affect the buyside. Firms with aggregated average notional amounts of OTC derivatives greater than EUR/USD 50 billion will have to exchange initial margin for derivatives that are not cleared. The Average Aggregate Notional Amount (ANAA) threshold for Phase 6 is EUR 8 billion. Firms will have to start posting initial margin only when their Initial Margin calculation versus a specific counterparty exceeds EUR 50 million.
Where do you see the biggest impact?
There will be a number of challenges in terms of the operational burden. You will have to be able to calculate the margin requirement versus each counterparty and agree the amount with them. You need a model and a process to do this, and you must include the ability to perform back-testing. You will also have to post the margin to a segregated account with a secure counterparty of their choice. This represents both a documentary and operational challenge as it may require the establishment of multiple new relationships.
What solutions does Eurex offer?
I think the most obvious solution is to encourage as many firms as possible to start clearing, even if – like government entities, supranationals, pension funds, etc – they have an exemption from clearing. And even firms that might be just under the threshold will still need to keep doing the calculations to assess if they remain so or not. With central clearing, you will still have to post margin, but only with one counterparty, using standardized and transparent calculations and you have a wide choice of collateral and are fully segregated.
What other benefits does clearing fixed income offer?
Most firms are already active in ETD, fixed income futures and options, so they can clear OTC in the same account, meaning they receive cross margin benefits and can use existing clearing brokers with whom they are already connected. They will also be able to then use the same operational processes to post margin. Additionally, they can now access cleared repo which will not only lower funding costs but also remove the bilateral counterparty risk, open up the opportunity to trade with a wide range of counterparties without any additional legal documents, and secure better prices due to the capital efficiencies the banks realise.