Relieving the Segregated Collateral Release Bottleneck
I’ve written recently about how current market conditions are impacting traditional margin call processes. While these changes may be a temporary response to the pandemic, the massive shift to remote working will likely prompt a long-term transformation toward automation of margin call activities as companies look for opportunities to create a more efficient system and mitigate operational risk.
What’s driving this is the evolution of derivatives trading and the continued reliance on manual processes for post-trade processing. While much of this activity has been automated for other asset classes, margin processing and settlement activity is still frequently managed with faxes and emails, forcing these transactions to be segregated from other processing activity. While this has long been a pain point for the industry, the problem has become exacerbated in a remote work environment. With the likelihood that these arrangements will continue after the crisis, the urgency to automate will accelerate.
One part of the collateral lifecycle has stubbornly resisted to change: the use of authenticated fax messages to authorize the release of segregated collateral held in third-party custodial accounts. If this one step could be automated, it would ease the strain on broker-dealers, buy-side firms and custodians, who are already being overwhelmed by margin call volume. The problem will increase exponentially over the next two years as buy-side firms are mandated to comply with phases 5 and 6 of the Uncleared Margin Rules (UMR).
While Covid-19 is shining a bright light on the issue, broker-dealers have been saying for some time that managing existing segregated collateral arrangements was a serious challenge for them and would worsen as UMR coverage expanded to buy-side participants. The International Securities Association for Institutional Trade Communication (ISITC) has raised similar concerns about the need for increased automation around this process.
Fortunately, solutions exist that will consign the use of faxes to history. For example, we’ve enhanced our Margin Transit Utility (MTU) service to follow ISITC-published guidance to fully automate the segregated release process for broker-dealers using the SWIFT MT527 message type. Those familiar with the service will recognize that this release builds on MTU’s ability to carry settlement instructions to both third-party custodians and triparty agents on behalf of its buy-side users, providing real-time status updates back to clients’ own collateral management platforms. In this case, MTU enables a broker-dealer to onboard a collateral agreement ahead of the buy-side client and, because MTU can identify an agreed return of collateral from the data supplied by AcadiaSoft’s matching service, immediately activate the segregated release process. Innovations like these will help improve the entire margin call processing ecosystem to the benefit of individual firms and the industry as a whole.
Like all crises, COVID-19 is an inflection point for the industry. It will change how we do business in ways that we can’t yet imagine. However, on pressing matters like UMR, we can help guide firms to a better future of increased automation, efficiency and risk mitigation.