What’s become clear to financial services firms across the globe is that recent regulatory mandates and liquidity requirements mean there will be a huge surge in demand for collateral and an increase in margin call activity. Less clear to the firms, however, is how they will marshal the resources to meet this expected upswing in demand.
One way the industry can respond may lie in a new joint venture that brings together two of the world’s largest post-trade market infrastructures, DTCC and Euroclear, to create the first industry-owned collaboration on collateral management infrastructure.
“Many market participants feel like they’re navigating into a perfect storm,” said Mark Jennis, Executive Chairman of DTCC-Euroclear Global Collateral Ltd. “Our mission is to help them navigate through it.”
Jennis said it’s difficult to gauge how much additional collateral firms will need to post as a result of new derivatives legislation, liquidity requirements and regulatory mandates. Estimates vary from as little as US$800 billion to as much as US$10 trillion, but the exact number is almost beside the point. Firms are going to have to identify and post significantly more collateral than they have in the past. The same is true of margin call volume, which some industry observers have estimated could jump by as much as 500 to 1,000% as a result of changes resulting from Dodd-Frank legislation, European Market Infrastructure Regulation (EMIR) and Basel III mandates, as well as from global fragmentation in the clearing of over-the-counter (OTC) derivatives.
“The message from the industry is clear – the vast majority of firms do not have the appropriate tools at this time to efficiently mobilize collateral,” Jennis said. “Nor do they have automated processes in place to manage increased margin call activity. They are rightfully concerned that this will result in increased costs and risks.”
On top of that, according to Jennis, many firms fear that the increased volume of activity may overwhelm their current operational processes and systems. He said it’s likely numerous firms will need to reengineer their collateral management processes to create an automated, transparent and more efficient operational environment.
These forces sparked the idea behind the creation of DTCC-Euroclear Global Collateral Ltd. The firm’s objective is to deliver a straight-through margin and collateral processing utility that can provide both derivatives and financing collateral management, enhance access to collateral regardless of location in the world, and address the substantial costs and risks of collateral processes across products.
“Our mission is to streamline collateral processing on a global basis and deliver transparency, mobility, efficiency and security to the marketplace,” Jennis said. “We believe our solution has the potential to offer unprecedented operating efficiencies to the industry while protecting the stability and integrity of the financial system.”
To meet its mission, Global Collateral is building two new market utilities.
The first, the Margin Transit Utility (MTU), will enable the straight-through processing of agreed margin calls in order to improve transparency around margin movements and record-keeping. The ultimate goal is to drive down fail rates, which, in turn, should help reduce the overall funding needs of participating firms.
The second is the Collateral Management Utility (CMU), which leverages Euroclear’s Collateral Highway to automate collateral management tasks, including the seamless re-positioning of inventories across settlement locations. The result will be to allow clients to make collateral available wherever and whenever it’s needed to meet any type of obligation a major achievement that will increase collateral mobility by eliminating the bottlenecks that can hinder the efficient movement of collateral across the globe.
The strategy that underpins Global Collateral, according to Jennis, is collaboration. “We know that by bringing these two utilities together into a single offering, we can provide the industry with a highly integrated, strategic solution that will support the entire collateral lifecycle and do so for the broadest range of clients, including the buy side, the sell side, clearing brokers, CCPs and custodians.”
In addition, Global Collateral’s open architecture global infrastructure will create opportunities to leverage other infrastructures, such as Omgeo ALERT, the SWIFT network, trade repositories, Acadiasoft and legal entity identifier (LEI) utilities. Global Collateral will be able to connect with a user firm’s internal collateral systems. These integration points will further automate manual processes and bring greater efficiency, transparency and safety to the management and movement of collateral.
“We believe Global Collateral will help resolve the many collateral-related challenges facing firms today,” Jennis said. “The perfect storm may be coming, but we think we have a way to help the industry navigate through it.”