Increasingly IMminent

 ISDA CEO Scott O’Malia recently published a post exhorting the wider industry not to fall into the trap of complacency in respect of IM compliance. While Mandy Rice Davies’ “Well he would, wouldn’t he” might spring to the more flippant mind, the points are well made and worth underlining. On 3 April 2020, responding to the pandemic, BCBS/IOSCO announced a one year delay to IM Phases 5 and 6. While in-flight negotiations continued, the market essentially breathed a sigh of relief and downed tools (refocused resources) for the interim. In terms of compliance challenge, Phases 5 and 6 are the Himalaya to the foothills of previous phases- the interim is over.

Not in Kansas any more

IM 5 and 6 differ from their antecedents primarily by the vast volume increase. ISDA have updated their estimates- anticipating 314 in-scope entities for Phase 5 and a further 775 for Phase 6. This amounts respectively to 3,616 and 5,443 counterparty relationships that require de novo documentation. The volume of Phase 5 alone represents a multiple of all other phases to date combined. IM expertise remains a relatively rare resource, confined to earlier phase in-house teams, a small number of law firms and an even smaller number of specialist consultancies. The supply of experienced practitioners will not suddenly increase to account for the Phase 5 demand.

Tempus Fugit

While the traffic will more than double, the road to compliance remains as narrow. The formal Phase 5 deadline is now 1 September 2021, phase 6 one year later. The experience of every IM phase has been that the regulatory deadline will not be passed unless custodian documentation is in place much earlier. Failure to do so resulted in a large number of Phase 1 dealers unable to trade immediately following the initial IM deadline; custody documentation has remained a critical compliance choke-point. The entrance of more custodians, each with their own slightly differing procedures and documentation, will only exacerbate the issue. The Phase 5 multitude will still have to squeeze through essentially the same custodian gates: onboarding, KYC, ACA negotiation, account set up and more. Accordingly, for each phase the first deadline is end Q1– less than six months from now. Experience in earlier phases shows that starting from fresh, time to full IM operational and legal compliance is typically 18 months, the pressure cooker conditions imposed by increased numbers are likely to lengthen this timeline.  

No Deus ex Machina

There is no magic bullet on the way. Recent innovations such as ISDA Create, AcadiaSoft Agreement Manager, and online portals at the largest custodians will streamline processes, reduce inefficiencies and allow for digital delivery of legal data. However welcome and vital their contributions, the hard miles of operational setup and testing and document negotiation will still have to be walked. While industry advocacy to permanently shelve Phase 6 continues, it is becoming clear that along with other Coronavirus delays, cancellation is not on the cards.

In conclusion, if you expect to be in Phase 5- engage with your custodian (and that of your counterparty) now and choose a partner to expedite. If you expect to be in Phase 6, begin to secure resources soon- while they are still available.

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