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A Look at What Lies Ahead for Derivatives Reform

By Michael Bodson, DTCC President & CEO | October 2, 2018

A Look at What Lies Ahead for Derivatives
Michael Bodson, DTCC President & CEO

I had a chance to catch up with a number of my colleagues at an event we hosted last week on the issue of collateral management. What fascinated me most was that regardless of what segment of the market they represented, the topic of our conversations was the same – the importance of enhancing capital efficiencies and liquidity management. This reflected a noticeable shift from talks we’ve had in the past, which focused mostly on the need to achieve greater operational efficiency.

Don’t misunderstand me – operational efficiency is still at the top of the agenda for many firms because the initial margin rules that go live in 2019 and 2020 will spark a significant increase in margin calls and a corresponding liquidity crunch. However, what I’m sensing now is a growing realization among market participants that the next phase of derivatives reform will require all of us to place an increased emphasis on capital efficiencies and liquidity management because these areas drive investment performance for clients and investors.

So what’s prompted this reset of the industry’s priorities? A lot – from the need to optimize collateral more efficiently to the importance of making the settlement process more scalable, reporting collateral positions and collateral valuations faster using standardized processes and the after-effects of demanding new regulations that require more efficient collateral management.

When you look at the totality of these dynamics, it’s not hard to see why optimizing available and eligible collateral will remain a challenge for the buyside and dealers across their large product sets, including OTC derivatives, Exchange Traded and Cleared derivatives, TBAs, and repos.

We’ve developed a unique perspective on these issues from our experience operating DTCC-Euroclear Global Collateral – a joint venture we formed in 2014 to enhance collateral processing. From this vantage point, we’ve identified three key ways for the industry to optimize collateral.

The first is data. It’s probably the most important resource available to all of us, and the good news is that our firms are brimming with stores of data waiting to be analyzed. But the value of this data can only be maximized if it’s formatted in a standardized fashion and available in real-time – areas of focus that we’ve prioritized at Global Collateral because we understand that they’re essential to maximizing the value of your data.

The second is globalization of assets. Firms need to be able to quickly and easily move collateral to the most efficient geographic location to enhance the financing or settlement process to limit risk. This has become a critically important topic for the industry as the settlement cycle for collateral has compressed from T+2 or T+3 in the past to T+1 in U.S. and EU markets. We’ve solved for this by building a connection between The Depository Trust Company (DTC), our depository subsidiary at DTCC, and Euroclear so firms can source more eligible assets for both collateral and financing purposes quickly and efficiently regardless of the need.

And the third is the process of selecting, settling and recognizing collateral. With upcoming regulations driving multiple account structures and locations, the ability to facilitate movement and recognize settlement is going to be tantamount to managing risks. We see speed and efficiency, combined with greater automation that enables real-time reporting, as the keys to success here.

Last week’s conference reinforced one thing for me – as we’ve seen with so many other regulations aimed at different parts of the financial markets, priorities will continue to evolve in expected – and sometimes unexpected – ways. Today’s focus is on more efficient processing, improved collateral optimization and reduced capital and liquidity constraints. What tomorrow brings may be less clear, but as long as the industry continues to collaborate, share insights and add to the melting pot of ideas, we’ll tackle and overcome these challenges together.