Andrew Douglas, DTCC Managing Director, Government Relations for Europe and Asia
As Europe considers the mechanisms by which it might promote a Capital Markets Union, it is essential that collateral move smoothly and efficiently across the financial markets, both in Europe and globally as a way of supporting investment into the European Union. Collateral is a crucial element of the efficient functioning and funding of global capital markets and therefore a key component in any growth strategy.
Market participants face increased collateral and margin requirements as a result of new derivatives rules such as mandatory clearing being implemented globally, and firms are becoming increasingly concerned about their ability to comply with the new regulations. Yet despite the anticipated increase in the demand for collateral, many institutions do not manage their collateral resources efficiently, finding it difficult to manage global inventories or effectively mobilize collateral due to siloed systems across jurisdictions.
As in so many other areas of the financial markets, the enemy is fragmentation.
Moreover, although a recent study by the London School of Economics suggests there is likely sufficient total collateral in the system to meet the demands of these evolving requirements, weaknesses in financial infrastructure could lead to collateral bottlenecks. This could lead to eligible collateral becoming immobilized in one part of the system and therefore unavailable for use in other parts of the global system. Given that the derivatives markets are highly interlinked, this inability to view and mobilize all available collateral on a global basis would have a knock on effect across the interconnected markets and actually create collateral shortfalls where none exist, particularly during times of financial crisis.
While firms are increasingly aware of their need to review and update their processes to account for new collateral and margin requirements across a myriad of jurisdictions, it is essential that market participants also leverage community-based infrastructure solutions that provide significant additional risk reduction and cost saving benefits by increasing scalability and operating and capital efficiency, and providing greater transparency across collateral activity.
This type of collaborative approach at the industry level is critical to ensure that market participants are adequately equipped to adapt to this dynamic and rapidly evolving marketplace.
This article first appeared in the Eurofi High Level Seminar 2015 newsletter