Brevan Howard is by no means a minnow— the size of its derivatives book alone attests to that fact—but it found itself traveling down a road signposted mainly for the banks that had gone before.
“It was clear that there were a couple of things that the sell-side may not have thought about,” says James Cousins, general counsel at Coremont, who led the project on behalf of Brevan.
IM—as opposed to variation margin, which is based on changes in daily market value—is typically required to be placed in a segregated account. But buy-side firms have not traditionally had to establish such an account in order to receive IM from a dealer. Updated legal documents needed drafting and there were some elements banks had to go away and think about.
“In terms of documentation, we had commercial agreements in place with all of our counterparties that dictated how we segregated IM previously, but those docs were not the same as the new standard forms that the sell-side had been negotiating between themselves, so we had to do some work to bridge the gap between the agreements,” Cousins adds.
The fund’s first step in the process was to give notice that it had determined one of its funds would likely breach the phase-three threshold and that its counterparties would be obliged to both post and receive collateral. Those notifications were sent out in March 2018, well ahead of the September 1 deadline.
While Cousins focused on the legal and documentation issues, Katz began investigating the technological readiness of the fund for the challenges ahead. It was clear that the rules would require Brevan to interface with myriad external counterparties, from their own custodian and their counterparties’ custodians to margin-call and messaging platforms. The firm selected BNY Mellon as its collateral segregation agent.
“We got underway well in advance; we chased our counterparties when we needed to; and we made it to the finish line on time,” says Katz.
Brevan Howard also had to familiarize itself with the intricacies of the Standard Initial Margin Model (SIMM), used to calculate the IM required on non-cleared derivatives. SIMM hinges on trade sensitivities which, though somewhat straightforward to compute for relatively vanilla instruments, can be more difficult for more esoteric derivatives.
Getting to grips with SIMM took “a couple of days of quant work” for Coremont given their strength in complex mathematical modelling, says Katz. But he acknowledges that it may present more difficulties for buy-side firms whose core competencies are not quantitative analytics.
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