The way that the financial services industry thinks about collateral has changed dramatically because of new regulations promulgated in the wake of the 2008 global financial crisis. How can collateral be managed more holistically to mitigate the impact of new capital requirements? Should clearinghouses consider becoming direct or indirect participants in central clearing to aid their counterparties in managing their capital?
According to a panel of industry experts gathered for the 2017 Global Collateral Conference, which was hosted by DTCC-Euroclear GlobalCollateral in New York on September 19, these are questions that only scratch the surface on the myriad of issues that market participants are currently contemplating.
The panel discussion, entitled, Industry Leaders Talk: Building the next generation of collateral management architecture across cleared, uncleared and secured financing, was moderated by Ciaran O’Flynn, Managing Director, EMEA Head of Bank Resource Management, Morgan Stanley and included leaders across the industry: Eric Aldous, Managing Director, Global Head of Futures, RBC Capital Markets; Sam Priyadarshi, Head of Portfolio Risk and Derivatives, Vanguard; Suzanne Sprague, Managing Director, Credit Risk, Banking & Solutions Clearing Division, CME Group; and Murray Pozmanter, DTCC’s Managing Director, Head of Clearing Agency Services and Global Operations.
A “Trifecta” of Challenges
Each panelist responded to what they termed as a “trifecta” of challenges – uncleared margin rules, clearing mandates and the Basel regulations – that the industry is facing and shared insights about some of the solutions that their firms are weighing to overcome them.
While problems like how to lower capital costs and improve payment efficiencies and collateral mobility seem clear, depending on where you sit on the market participant spectrum, how to solve those problems may seem less so.
“I don’t think there’s one single model for clearing that will get the whole market in,” one panelist noted. “I think that’s going to be a combination of several different solutions that are going to work for different types of entities.”
Those solutions range from new collateral services and products to technology innovations. Capital constraints will require firms to use their balance sheets much more judiciously as they look at how to allocate collateral and what types of collateral they are using.
The industry is taking a more holistic approach to problem-solving, and the intended and unintended consequences of the new mandates are a major driver.
“There wasn’t a pressing need for these conversations before,” one expert agreed. “It’s bringing people to the table now and getting everyone to work on things that benefit the whole community as opposed to one specific sector.”
Collaboration Makes the Market Go Around
Collaboration among market participants was a recurring topic among the panelists.
Because of the many process issues that need to be solved at the industry level -- moving the parties to these trades to venues where transactions are executed, to infrastructures where transactions are cleared and settled, to the entities that provide the collateral management services and potentially some of the collateral optimization services – having everyone on the same page is imperative.
“Firms are looking to see where and how they fit into the current landscape, so everyone is talking,” said one panelist. “I don’t think there are any pockets within the industry that aren’t involved in the conversation about how to move forward, so it seems like a very optimal time for some real change to take hold.”
In years past, the sheer number of participants made gaining consensus about a problem or challenge difficult. But, said one panelist, a surprisingly positive outcome of the industry’s reaction to new rules and regulations around collateral is that all participants – whether they are on the sell-side or buy-side, a technology provider, industry utility or financial market infrastructure like DTCC – now are focused on the same thing.
Participants are having dialogue about how improvements can be made on cross-margining agreements, how to help custodial banks creatively bring their clients into clearing and best practices for agent leaders who want to introduce clearing to their clients.
“If the industry agrees that there should be a more centralized solution for coping with some of the new regulatory requirements, such as collateral optimization requirements or consolidation of collateral management, then there’s going to have to be an unprecedented level of cooperation across the industry to get this to work,” one panelist explained.
Bringing the Industry Up to Speed
Ironically, one of the industry’s greatest challenges could become one of its biggest opportunities.
Firms are looking for better alignment, increased efficiency and lower costs. All are factors which are currently driving industry infrastructure to look at how it can expand, what types of assets are accepted as collateral and how it allows them to offset both collateralization and liquidity requirements.
Meeting the challenges will require a combination of investments in robust architecture aimed at allocating resources appropriately as well as industry standardization.
“We see a lot of promise in some of the new technologies that are out there,” one panelist stated. “But where we see the biggest risk is new technology – while in and of itself could enable efficiency in certain processes – that could create more fragmentation in the industry.”
Panelists warned industry participants to proceed with caution and avoid creating new problems in an effort to solve an old one.