Do asset managers and other buy-side entities have the resources and infrastructure in place to comply with new collateral-management rules for OTC derivatives that are set to take effect in March 2017? How will the buy side manage the ensuing documentation complexities as thousands of collateral accounts are created? Will regulators clarify various operational details that remain unresolved?
These were among the issues addressed in a panel discussion at the 2nd Annual Global Collateral Conference sponsored by DTCC-Euroclear GlobalCollateral LLC. The event, held September 20 in New York, attracted a full house of attendees across the spectrum of market participants—buy side, sell side, regulators and policy makers, custodians, advisors and service providers.
The buy-side session, “The Long and Short (Term View) of Regulatory Compliance for the Buy Side,” was moderated by Ted Leveroni, Chief Commercial Officer for DTCC-Euroclear GlobalCollateral, and included Judson Baker, Senior Vice President, Derivatives Product Manager at Northern Trust; Abhijit Choudhary, Global Head of Trade Management, Goldman Sachs Asset Management; Wayne Forsythe, Managing Director, Collateral Management Services, at State Street Global Services; and Laura Martin, Managing Director and Associate General Counsel, SIFMA Asset Management Group.
Square Peg, Round Hole
While it will affect the entire derivatives industry, implementing the variation margin requirements that kick in next March—resulting in more, and more-frequent, margin calls—poses some special challenges for the buy side. Panelists noted, for example, that because asset managers transact with a portion of a legal entity, consolidating margin calculations will not be a natural fit for these entities.
“We didn’t use to worry about inventory management but now it becomes important,” said one panelist. “Do you have enough inventory in the portfolio [to use as collateral]?” And what is the composition of that inventory—“what are the same-day trades that are happening? What trades are settling? It will require messaging standardization.”
Same-day settlement of derivatives trades will further complicate inventory management for asset managers, another panel member said. “Where is the location you are supporting for particular collateral activity? Will the information be delivered early in the morning, so you can insure portfolios are reconciled, validation checks are done? And will they be within the cut-offs? We’re having conversations with our custodian partners about the flexibility on their end.”
For global players, challenges loom around managing a daily calendar with multiple cut-offs. We confront a “complex web of cut-off management,” said a panel member. “There's the security market cut-off, the custodians’ cut-off, and your counterparty’s—wherever those offices are located.”
A panelist noted that most of his firm’s clients—sovereign wealth funds, pension funds, asset owners in general—have multiple asset managers to which they delegate ISDA authority, rather than negotiate their own ISDAs. The result under the new rules will be “very, very small increments of collateral movements, and therefore a number of fails, a number of reconciliations—an unfortunate byproduct of these regulations.”
The documentation challenges of the new collateral management mandates are daunting, panelists said. Not only may existing counterparty agreements need to be rewritten, variation margin requirements may spawn countless new ones.
For the impending repapering of existing credit support annexes (CSAs), buy-side firms are seeking operational simplicity, ideally in the form of a single, modified credit agreement for each portfolio. “Most asset managers would like to have a single regulatory compliance CSA and they could bucket all their trades to that,” said one panel member.
But the feasibility of such an approach is uncertain, the speakers admitted. Besides the existing products that are covered by a CSA, any entity trading non-deliverable forwards (NDFs), will now have to provide margin and its related documentation, one panelist noted. Furthermore, the preferences and capabilities of dealers and custodians in repapering CSAs will dictate the shape of final documentation.
“While asset managers favor having one CSA, what is workable across counterparties” will determine the outcome, a panelist said. “The feedback we’ve gotten indicates dealers will stick to the old credit agreements for old trades because they don't have the legal and other resources now to modify all the old agreements.”
Looking to Infrastructure
To enter the new world of collateral management, firms need to revamp their operational practices. Retooling the infrastructure to streamline collaboration among internal teams and with external partners is necessary, panelists asserted.
Ten years ago collateral management was not a focal point of a firm’s operations, said one speaker, but “now, it’s a partnership. A cross-functional group—going from portfolio management to the middle office to the central funding desk to service providers—needs to be involved to insure assets go into the same portfolio.”
Such a structure requires “connectivity from front to back,” said another panel member. “Communication of your positions and reconciliation back to the front office requires a completely different infrastructure [from what we have today]. If you hadn't thought of this as a great STP [straight-through processing] opportunity, the new regulations have forced you to look at it.”
All the panelists pressed the STP theme. “As an industry, we must put significant focus on infrastructure build-out and messaging standardization to manage our collateral activity going forward,” said one.
While centralization of all margin functions “seems like low-hanging fruit,” observed another panelist, “it is difficult to implement.” Despite the challenges, “firms are going down that road.”
There is a silver lining in these regulations, said a panel member: they will force investment in core infrastructure and bring potential new efficiencies.
“We’ve got to automate end to end,” said another, “and utilities like GlobalCollateral can help us with that.”
Collaboration is Key
Asked what collateral management for the buy side will look like in the future, one panelist said, “My dream is a centralized collateral solution for a multi-product class. I don’t know if we can get there in five to 10 years but hope we can eventually.”
To move toward that goal requires engagement with stakeholders, all speakers agreed. Spend time with customers, work through industry groups, learn how other firms view the impacts of regulations, and figure out where we can cooperate, one panel member advised.
“We have a long way to go and don't even know all the challenges we'll face,” said a panel member. “Let’s continue this industry collaboration, so we can address the challenges together.”