Unpacking EMIR RTS on Initial Margin Model Validation

By John Pucciarelli – Head of Industry & Regulatory Strategy, Acadia

The industry has been waiting with bated breath for the past two years to discover the European regulators decision on how firms that are in scope for uncleared margin rules (UMR) are required to validate their initial margin (IM) models.

On 4th November 2021, the European Banking Authority issued the Draft Regulatory Technical Standards
on Initial Margin Model Validation (IMMV). Within the consultation document, they clarify the proposed requirements for IM model validation (ISDA SIMMTM) which we will aim to distil specifically for Phase five and six firms. Please note: The RTS is in draft status, with the comment period closing on 4 February 2022. The interpretation of the draft RTS is Acadia’s opinion and should not be treated as legal advice.

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• The RTS covers all counterparties within the scope of EMIR UMR

• The RTS establishes validation process for banks above €750 bn AANA using a ‘standard’ process’:

• The standard and simplified process begin the same way by submitting to their competent authorities the request for initial validation of the model, any material changes to it, and extensions to the model inclusive of proper documentation

• Generally speaking, the standard process (for firms over Euro 750 Bil AANA) aligns with current practice of backtesting, model governance, extensions as they do today, one material difference is the RTS specifies the ability to outsource the IM model validation process to a third party and re -use the results of previous validation process to reduce redundancies and inefficiencies.

• Outlines that firms ensure senior management has a good understanding and is actively involved in managing the IM model. And have the sufficient of size and independent audit functions within their firms to implement, test and validate the model on an ongoing basis.

• Static Backtesting to run at least every 3 months using the standard traffic light method to identify exceedances

• Establishes the use of a dynamic back test to ensure day over day performance of IM ensuring the model is fit for purposes.

• The RTS establishes a ‘simplified’ process for all entities under the €750 bn AANA (Phase 5 and 6 of UMR)

• The simplified process for model validation is as follows:

• Utilization of a Dynamic Backtest does not require a Static Backtest

• Is similar to the standard process in so far as firms will need to apply for model approval and validation to their competent authorities initially and ongoing.

• Any ‘Non Significant’ as defined in the RTS (see section 3.2.2) changes or extensions to the model need only be reported once a year

• As a standard rule, subjects under both Standardised and Simplified Supervisory Procedures shall obtain the IM model’s supervisory validation before being allowed to implement the model, except during the transitional phase (see Section 3.3)1

• Allows for outsourcing of the validation requirements

• Refers to a phase in for Phase 5 & 6 firms 2 and 3 years respectively after entry into force

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1 These RTS propose a transitional provision (Article 30), which establishes that counterparties already implementing an IM model and applying for the supervisory validation in due time (one month from the entry into application of the provisions in these RTS) would be allowed to keep using the IM model. During the transitional phase, once the counterparties have applied for the supervisory validation, the competent authorities will have up to two years to raise any issues on the model implementation, based on the requirements in the regulatory framework

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About John Pucciarelli

John Pucciarelli is Head of Industry & Regulatory Strategy at Acadia. John is leading Acadia’s outreach to IM phase 5 & 6 firms building on his knowledge and experience as well as overseeing Acadia’s interactions with global regulators and industry associations. John was previously with The International Swaps and DerivativesAssociation (ISDA) as Director of Market Infrastructure and Technology. John led margin and collateralInitiatives for the ISDA membership overseeing the implementation of the initial phases of the non-cleared margin rules from an operations and business perspective. Prior to joining ISDA, John was with AQR CapitalManagement where he oversaw their middle office operational functions. Earlier on in his career, John worked for UBS Investment Bank where he supervised their US Equity Prime Brokerage Operations team.

For more information please visit us at acadia.inc Or email us at info@acadia.inc

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