Phase 5 and a likely Phase 6 of the Initial Margin Regulations, are around the corner.  Banks, insurance companies, hedge funds, pension funds, large corporates and asset managers with books of over $/€8 billion of outstanding derivatives will have to comply, and the legal demands are huge.

“The firm is widely seen as a thought leader when it comes to explaining all the new issues facing global derivatives regulations. But it also innovative and a leader when it comes to drafting those changes” Mayer Brown Cuts Through on Margin, Global Capital, September 2019

Having 50 ISDA Master Agreements in place could require an insurance company, for example, to negotiate over 300 new agreements, subject to 6 governing laws, whilst meeting the rules of four regulatory regimes. 

Mayer Brown has a market-leading team ready to guide our clients through the biggest challenges to ever face the derivatives market. Our acclaimed YouTube series, “Initial Margin for Uncleared Derivatives in 2019 and 2020” covers the major issues.

“Having 50 ISDA Master Agreements in place could require an insurance company, for example, to negotiate over 300 new agreements, subject to 6 governing laws, whilst meeting the rules of four regulatory regimes.”

What’s it all about?
The EU’s EMIR Margin RTS, the US Dodd-Frank Act and other key global regulations have been phasing in a requirement for counterparties with more than $/EUR 8 billion (or equivalent) gross notional amount of uncleared OTC derivatives to collect Initial Margin (“IM”) from other similarly affected counterparties. 

The margin must be segregated, so these arrangements are called “IM Seg” requirements. See Episode 1 of Series 1 of our Initial Margin Series, for a full overview.

This is being introduced in phases. Originally, there were supposed to be five phases, now there are likely to be six. Phase 1, which took effect in September 2016 and February 2017, obliged counterparties to post and receive IM with similarly affected Counterparties in cases in which both had a gross notional amount of derivatives over $/€3 trillion. 

Phase 2 in 2017 and Phase 3 in 2018 captured Counterparties having a gross notional amount of derivatives over $/€2.25 trillion and $/€1.5 trillion, respectively. Phase 4 in 2019 reduced the threshold to $/€0.75 trillion.   

Phase 5, which is applicable from September 2020, was originally scheduled to capture counterparties with a $/€8 billion of derivatives, is now likely to apply to a higher threshold of  $/€75 billion, with the  $/€8 billion threshold being delayed to a new Phase 6 in September 2021.  

Industry estimates are that as many as 1100 banks, pension funds, asset managers and insurance companies will have to comply with Phase 5 and 6.  The Phase 1-4 financial institutions are also faced by massive challenges: they must put in place compliant documentation with those now caught by the rules.

The documentation requirements are huge. Industry estimates are that 9,500 ISDA Master Agreements will require new or amended documentation, and as many as 19,000 segregated IM custody accounts will need to be set up.

The volume and complexity of legal agreements that require negotiation presents an unprecedented challenge to participants in the derivatives market. See Episode 4 of Season 2 of our Initial Margin Series, for our discussion of the scale of the task.

To put this in perspective, an insurance company with 50 ISDA Master Agreements in place, could need to put as many as 300 new documents in place under English, Belgian, French, Luxembourg, US and Irish law.  These might include IM Credit Support Annexes, Credit Support Deeds and Collateral Transfer Agreements; distinct Account Control Agreements and Custody Agreements, and ancillary documentation.

How can we help?
To meet that challenge, affected organisations will need to have access to:

  • global legal and regulatory advisory capability;
  • large scale outreach and IM negotiation and execution capability; and
  • comprehensive advisor capability to advise on custodian, model and infrastructure  selection and implementation.

Mayer Brown has been working together with alternative legal services provider DRS and consultants Margin Reform to create a separate, but integrated, arrangement: IMpact3.

It is a compelling cost effective service providing high quality regulatory advice and legal analysis by Mayer Brown implementing the right IM infrastructure; together with separately provided cutting edge execution from DRS, and advisory services from Margin Reform.

An affected financial institution facing Phase 5 and the likely Phase 6 will have these needs from its advisors:

  • Template and playbook development: preparation of template IM Documentation; and preparation and maintenance of negotiation “playbooks”;
  • Advice on complex/bespoke issues: consideration of complex or bespoke (i.e. non-playbook) legal and regulatory issues arising during IM negotiations, across multiple jurisdictions; and
  • Post-completion assurance: drafting compliance/legal memorandums (if required); assisting with registration obligations (if required).

These services are provided by Mayer Brown. An affected financial institution dealing with Phase 5 and Phase 6 will also need:

  • Paralegal Operations: creation of IM draft contracts; outreach & chasing; review of client amendments; creation of revised drafts; creation of execution copies; and maintenance of DMS/project data;
  • Review: to validate the output of the Paralegal team; ,manage escalation to Stakeholders; and ensure playbook compliance;
  • Liaison: liaison with an outside law firm and in-house legal teams and training; and 
  • Process Management Outsourcing: process management; production of management information; SLA/KPI monitoring and resource management.

These services are offered by DRS. In Episode 2 of Season 1 of our Initial Margin YouTube Series, we discussed the key issues. 

As part of Impact3, and before even starting this process, an affected financial institution will benefit from a consultant, who will apply knowledge gleaned from years of expertise on disclosure, technology solutions, model selection, collateral transformation, custodian selection and the many  other issues discussed here in Episode 5 of Season 1 of or our Initial Margin You Tube Series, with Chetan Joshi of Margin Reform.  

These services are offered by Margin Reform.

Please see our IMpact3 brochure for further credentials and background; and our episodes from our Initial Margin for Uncleared Derivatives 2019 and 2020 video series. E-mail Edmund Parker for further information and discussion.


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