Overview
In this landmark episode of Ahead of the Curve, John Pucciarelli is joined by Stuart Smith, Co-Head of Business Development. This is our first episode under the new LSEG Post Trade Solutions name and the podcast tackles key areas of the transition from ISDA SIMM 2.6 to 2.7, including notable changes, impacts and tips for firms making the giant leap. Amid the volatile global landscape, Stuart breaks down how the model and the reduction in SIMM across the industry raises both concerns and opportunities. Packed with a range of thought-provoking insights, this episode will be very useful for firms who will be adapting to the recalibrated model.
Listen to the podcast
Welcome, dear listeners, and welcome to another episodeof LSEG Post Trade Solutions, Ahead of the Curve.It might sound a little different where we were, Acadia'sAhead of the Curve, but now we're LSEG Post Trade Solution.Welcome, everyone, and thank you for joining us today.I am again with my colleague and my coworker, Stuart Smith.He is Co-Head of Business Development. Welcome, Stuart. Here we are again.Thank you very much, John. Nice to be here.We've talked about a lot of different subjectsover our time on the podcast. Right now, at the filmingof this particular podcast, we're here in October,last month, on September 19th is the published SIMM 2.7,and just like they always do. This is a normal year-end recalibration.Goes into effect on December 7th. I would sayit's uneventful, except for a couple of thingsthat we've looked at when they published the model.We're here to talk a little bit about that.We're going to talk a little bit about what has changed.What are the big headlines? I'm not going to steal your thunder,so I'm going to hand it to you in a second,but we're going to dive into it. It's very important for us as a business.It goes without saying. It's important for the industry.SIMM has been crucial for the trading and margin, andcollateralization of unclear derivatives. It's important to us,and I think looking at the recalibration this year is very, very interesting.Why don't we start with what is changing? What are the big things that we're seeing,and what are the things that you have observedfrom comparing 2026? -SIMM2.6 to SIMM 2.7. Let's let me look at the headlines first.We've often felt like the bringer of bad news at these recalibration events.The last few years, we've been persistently telling peoplehow much more they're going to have to postwhen the same recalibration goes through. In fact, this yearwe're doing the opposite. This is the first yearin quite a long time where we're saying there's going to bea pretty large reduction in the SIMM that's been posted across the industry.What does that mean? If we look at Phase 5 and Phase 6 firms.These are the hedge funds, the buy-side participants in SIMMrather than the larger banks. They post around about $130 billionof initial margin today. We think on December the 7th,when this goes live, they're going to get returnedabout $20 billion of that 130 that they're posting.That's a pretty significant number, and that's a pretty big reduction in thatis the same. Like we said, this is the first timesince COVID effectively where we've seen these numbers coming downas opposed to going up. It feels very much like we went through peaks in,and we're now a little bit of a downward trend, at least for now.We have something to show. Let's pull up and show some of like what's changing?Why is it changing? You mentioned COVID.That was the stress period that had been in the modelfor the last few years. -Interestingly, it was neverthe stress period. It was one of the three yearsthat people take as the calibration period,but it was, this probably the most stressful yearfor lots of reasons, but certainly financially stressfulas well. -You're talking about work from home.About my home schooling experience. That's the moststressful thing I've ever done. That 2020 was an incredibly stressful yearfrom a financial point of view, and it didn't go in the stress period.That was just part of our three-year historic lookbackthat was used to calibrate the model. In 2.6, you've gottwo full stress years in there. You've got 2008,2009 with the financial crisis, and you've got 2020,the COVID lockdown period, with this huge equity and commodity shocksthat we saw throughout that year. Unsurprisingly, if you put intwo very stressful years into a calibration,you get out a model which is calibrated to a very stressful level.We saw that through the high SIMM postings that came off the back of that.What happens this three-year window rolls forward,and it rolls forward from 2020 being the earliest year.The calibration for this year, 2.7 2021, is the earliest year,so 2024 is out, and it doesn't fall out completely.It was such a stressful year. It now replaces part of that 2008,2009 period as the stress period that we use,but remember, that's only one year. Now we can only have parts of eachof those to make up that stress part of the calibration,and inevitably, that brings the calibration down.If you look at 2023, by comparison, it wasn't an uneventful year,but compared to 2008, 2009 or 2020, it was a very uneventful yearif you look at it in that perspective. -Two thousand and eight, 2009,by all accounts, is the stress period that will remain as partof the plus one for quite a while. -It's hard to say this isn't somethingto discuss publicly, but yes, I think there were some unique thingsthat happened in that period, and the way the spreads moved,I think it's very unlikely we'll see somethingas impactful as that, and it replicated again. I think it's very likelythat I'll stay in for the duration. -We can switch gearsa little bit now and talk about what's the implications,what's some of the things that you've been hearing from the market.I know it's fairly new. We do have a tool that can comparethe two models side by side and see the impact.I know you talked about risk and had an article published recently,and talked over some of those implications.What are some of those things? You would think getting more collateralback into the system is a good thing. Generally, it's probably goingto be welcome. What are some of the observationsfrom your perspective, or have you heard anything from clients yet?We know that banks are constrained either by capital or by their LCR metric,so they're constrained as to the business that they can do.The general perception is that reductions in costs such as theseshould free up banks to do more business. Currently, those guys, rather than--they're constrained by what sat on their desk,what access to resource they have. This should free upa very considerable amount of resource for those guys to be able to do more.I think what you should expect to see in December and going in Januaryis an increase in the business that's coming out of big banks,an increase in the competition, more peoplethat can grow against different derivatives, less peoplethat are locked out from doing trading because of the positionthat they're in on their desk, which I thinkis a great thing. That's going to be positive.At the same time, hedge funds are receiving backa pretty substantial amount of money that they've had tied up in collateral,which obviously they hate. That money you would expectto be put to use. I think you can expect to seea pretty high degree. -Ease up their funding.Because a percentage of the fund has to be in cash,which they have to raise through, let's say, repo trading.Maybe that will adjust. It'll be a little bit easier for them,or it will be less costly, perhaps to raise to raise that cash.Hedge funds, a lot of equity and bond posting.It's more common. There's still the vast majorityof collateral that gets posted in cash. This is a large lump of cash going back.I think you should expect to see a decent uptick in business,and the numbers we're talking about are significant numbersaround the quantity of money that's moving.Would we say 70 billion or 40 billion? -Twenty billion in each direction,20 billion going to the hedge fund and 20 billion going to the bank.That excludes the Phases one to four, the entire dealer market,which we know is much bigger than the Phase five to Phase six market.There's another pretty large sum of money. We did a little bit of analysis there.We haven't run the whole thing. Again, we think that 10 per centto 20 per cent reduction in posted collateralis pretty consistent across that group, too.These significant numbers. -On the dealer side, do you thinkthere's going to be balance sheet implicationsbecause of the cash that's being freed up, you mentioned capital.Do you think that it would be worth it for firms to do that analysis now?Do you think they're doing that and figuring outfrom getting all this extra cash coming in by virtue of the model change,what is that going to mean for my business?As we said, it is a net positive, but balance sheet is a thing,and they have to consider that. -I'm sure Phases1 to 4 banks are doing this. I think everyone got so burnedduring that post-COVID calibration, where the opposite happenedand the numbers went up by some 20 per cent, 30 per cent,a little bit more shocked into action to make sure they're on top of this.Going down is a little bit easier to deal with.It's a good problem to have. -If you look at just the positionthat you're going to receive, tens, hundredsor even billions of dollars on one day in December.You probably know what you're going to do with that money.In the phase, wonderful banks. I'm sure they have this covered.They have to, from a regulatory point of view,they've got to be doing the impact analysis.The Phase 5 to 6. We know that there's only reallya growing awareness that this happens every year.Some of the shocks have helped them be aware that this is happening.I think they're getting more in tune to the factthat I need to be on top of this and know what's going to happen.Just from a silly point of view. The faster I can invest that moneyand do something with it, is going to easily pay off my costof having done that analysis. Definitely, I think those firmsshould be looking at this and making a planwhere that collateral goes on the day they get back.It's close of business. The sixth, seventh is the effective date,and I think that Monday, which I think. -The Mondays the ninth.People listening to this know the order of operationsand how it's going to work. Most people thinkrunning the model know that, but it's probably worth mentioning.If we just look broadly at the change, and again, at the recording of this,it's fairly new. We're looking at it.You said there's more to come, really on the dealer side,to do more analysis to see what the impact is.I think we've touched on some things going into the future next year.The semi-annual recalibration is going to happen.I don't know if a lot of people are aware of that as well.That's something that was done last year and agreed to with the regulators.I guess there was one other point that I wanted to make.As we're talking about this and not that we're cheeringthat everything's going down, I think it's worthjust mentioning that through the process of recalibration,the regulators are completely involved in all of thisand sign off on the new model. It's not just ISDA saying, hey guys,we're taking out the year 2020, and here's the model.All the regulators need to look at it, need to sign off on it,and everyone needs to be on board, which is what happens.You look at what those large banks have to do.I mentioned they have to do an impact analysis.This is a model change for most banks. They need to impact analysisbefore they can release a model change. What does that mean for a big bank.They've got an underlying requirement to hit this 99 per centof the VAR of that three-plus-one period. They need to go backand redo that back testing with this new modelto make sure that the numbers they now get still cover that.That's the impact analysis from that point of view,is dead easy when the numbers go up. You're going to post 30 per cent,40 per cent more next year. If we covered it this year,it's definitely going to cover it next year.Then this is fine, but when it comes down and doing an impact analysisis much tougher because you need to demonstrateto a regulator. I'm still safe posting this much margin.Now I don't introduce lots of exceptions to my model.It still predicts what I needed to predict and doesn't cause me issues.I'm still comfortable now with the counterparty credit riskthat I'm running. There is quite a bit more work to do,probably there for banks to be able to justify that decrease,and of course, it's the banks who remain ultimately responsiblefor showing their model hits the regulatory requirement.That's not something to do. That's something the bankdoes correct as part of their responsibility.I just wanted to make sure that we noted that and not,like I said, not just applauding that there's more cash.I think you can argue as well. At this point,we use this three-plus-one methodology, which is what's driving the changethat we're seeing. You may look at the world todayand say, I feel like I'm in a very risky positionright now. The world feels in a volatile period,although it's not playing out in the financial landscape right now.There are several wars ongoing. There is an awful lot of riskout in the world. In some ways, while two financially flatfor nine years, allowing this number to come down, I thinkyou can you can make an argument about how is the modelsomewhat forward-looking as to the risks that maybe they're looking out for us now.That's what the stress is supposed to do, but there's definitely got to besome concern there about looking into the future and saying,we're in an unstable position right now. It feels.We can assume that, and we've already seen a slight change.The model is not that old. If we're talking about ten yearsfrom the beginning of that white paper and the idea of SIMM,till now, a little over 10 years, we've seen COVIDin that period. The regulators responded, saying that it wasn't nimble enough,hence the discussions with all the global regulatorsand the agreement to have a semi-annual recalibration,which will happen next year. Guess we can assumethat this model will continue to evolve. It'll continue to change,and it'll probably be more reactive than proactive, I would think,because it's hard. These things are hard to predict.That's why there's a back test and any model,any risk model, we have to look at the pastto try to predict the future, to ensure that we're covering as much,that 99 per cent 10-day empire, et cetera. It works for the most part.That's an interesting thought because it's true.I think a lot of folks, I'm not going to speak for everyone,probably feel that way sometimes. When you think about it, it's like,what's happening today, are we covered today?There is always a top-up. There are always things that you can doto add to the model in terms of more collateral.That's always an option for firms if they feel like certain positionsare going in a certain direction, whether you say right or wrong direction.That's all subjective. I think next year we'll see,when is the next calibration, or it's not going to be a model change.It'll be a recalibration. -Going into next year,that process has already started. I saw it kicked off next month or so.Collecting data. The model will be released,effective date in July. We won't quite get to next yearbecause the next one will come out in January 2026,but effectively, to next year. Is there a little bit cheatingin that they're allowing those processes to overlap,to buy themselves a little bit more time to be able to do those calibrations?If you think about the challenge they've got.They've got a large number of banks in that governance committee.This isn't a model where they can just decidewhat the change is. That's a large group that's driving that,which is lots of benefits from that diverse point of view,but does mean that they've got to get a lot of workdone, a lot of agreement created within a shorter time period.Inevitably, that's going to also reduce the time that we haveto implement that model and take it live. While you should expect smaller changesgoing forward, that period, it's still going to be a model changestill has to be validated. You need to get readyfor how you're going to do that a little bit quicker.Hopefully, everybody's taking this opportunityto refine their processes, make sure that they're nimble enoughto do this in a shorter time period. It hasn't let us know yet howlong we're going to have. We estimate three to six weeksfrom release of the model to the effective date going forward.Just on the basis, it's half of what we had currently.We'll have to see how that plays out and how long we get to do that in.We had a taste of it in May of last year, and of thatmiddle-of-the-year change. It'll be an uptake.It'll be a big change. I think firms are hopefully preparing for it.We're obviously as a firm preparing for it.As always, we're here to help and to navigateand help our clients navigate through that.It's interesting, and who knows what the future will hold.Volatile times. It seems like our continuing.It'll be interesting to see how the overall landscapeof whether it's SIMM or other types of riskmitigates change over time. That was great, Stuart.Was there anything else? I know we covered everythingthat we wanted to cover, I think. -Just floating out there to peoplethat we talked about SIMM coming down. There is, of course, one area,it's going up dramatically. RMBS/CMBS effectively aggregatedconsumer debt. This area has gone up spectacularly.It hasn't quite tripled, but it's almost tripled in risk weight.If you're trading in this area, you need to be particularly carefulbecause you're going to buckle. -If you're concentrated in that,then I guess the promise of it coming down is not going to happen.In fact, it's going to go much higher from the last model.When we did a sweep across portfolio, a huge range of outcomesfor different agreements. Some of the biggest changesactually were increases of up to about 50 per cent.Presumably, on portfolios concentrated in those asset classes.Is that coming from a particular year that we've shown up there?I think it's hard to explain exactly where that comes from.You've got to assume it comes from 2023 coming into that calibration.What happened in 23? Interest rate rises of courses,and, of course, those things are going to drivean impact on consumer debt. If you think my mortgagecertainly went up, I'm sure everyone else's did.I'm sure everyone else's credit card rates increased a bit as well.The consequence of that is you're a little bitmore likely to default, and therefore the value of those instrumentsgoes down a bit. I think that's the one area justto be aware of. Don't get caught out. -Thanksfor mentioning that, because I know that was part of the write-upthat we were looking at. Thank you, Stuart, for that.Anything else before we close? I know this is a topicthat we'll continue to focus on and make sure that our clients are ready,and we do calculate some for quite a bit of the market.It's near and dear to our hearts. It's very important for usand our clients. Anything you want to close onbefore we end? -No, I think just at that pointit's worth taking a look. Because if your treasury is just thatlittle bit more effective on the day you get that cash back,it's going to make it worth your while. It's worth taking a look,and it's worth planning ahead. -I think there's more to come.We'll see the impact of this in real time. When it goes into effect,it'll be interesting to see what the impact is going to bewith all this freed-up collateral, potentially will be.As always, it's great talking to you. I'm sure we'll be back againin this great studio. Love the studio. Thank you, Stuart.Thank you. -Thank you allfor joining this episode of Ahead of the Curve.I found it very interesting. I hope you have.You can find us on acadia.inc, YouTube, Spotifyand wherever else you stream your favourite podcasts.Thank you for joining us today, and we'll see you again soon.
