At DTCC’s Asia Pacific Collateral Management Forum, “Automating Collateral Settlement, Are We There Yet?”, a gathering of industry experts shared insights on managing margin requirements. The annual event – held virtually since the pandemic started last year – attracted a turnout of more than 133 attendees from buy-side, sell-side, custody and outsourcing firms across Asia Pacific.
During his opening remarks, DTCC’s Bob Stewart, Executive Director, Product Management for Institutional Trade Processing, discussed the impact of Phase 5 of Uncleared Margin Rules (UMR) for over-the-counter (OTC) derivatives, which kicks in on September 1, 2021. “There will be an upsurge in the volume of margin calls and an increase in the need for third party custodians to safe keep collateral. As a result, UMR will likely require many buy-side firms to make significant changes to their existing collateral management processes.”
He continued, “Many of these processes are very manual today, often leading to transactional processing errors and settlement failures. It is critical that in-scope buy-side firms are well on their way to preparing for compliance.”
Stewart commented that most firms have made good use of the one-year delay in implementing Phases 5 and 6 of UMR, making the necessary changes and upgrades to their collateral systems, platforms and processes; however, recent industry reports have indicated that there is still a huge number of in-scope market participant firms that are not ready to comply with the upcoming mandate.
Managing Manual Processes
Calling out the risks of non-compliance, Stewart highlighted that establishing segregated accounts with an unaffiliated third-party custodian is a new mandate – regardless of the model adopted (third party or tri-party segregation).
He added, “It is a mechanism that many buy-side entities may not have implemented in the past and it is important that all involved are comfortable with this process now. This will be a challenging undertaking as thousands of accounts within the industry are expected to be established. Opening a global custodian account is an extremely long and laborious process due to the multiple manual tasks required, including involvement with legal teams.”
Another area that calls for immediate attention is collateral release processing. Stewart indicated that this is a highly manual process where the industry is still relying on the fax machine and telephone to communicate, capture and verify instructions to release the required collateral between the buy-side firm and the global custodian and the broker and the global custodian.
“Many of these processes are very manual today, often leading to transactional processing errors and settlement failures. It is critical that in-scope buy-side firms are well on their way to preparing for compliance.”
Given that this arduous, time consuming activity will be repeated with every margin call, Stewart reflected that this environment was a perfect storm in the making when the global financial markets had to deal with volatile trading triggered by COVID-19 in the early part of 2020. With most of the workforce working from home then – without access to the fax machine and telephone numbers of counterparties – global custodians were struggling to execute collateral releases, resulting in elevated collateral settlement fails.
While the global pandemic was the driver to increase our momentum to improve margin and collateral processing, Stewart stressed that the lack of automation in moving collateral within the industry has created bottlenecks in collateral fails. This was especially evident during periods of market volatility where collateral movements suddenly increased between 200% to 300%. Stewart urged the industry to address this issue now – to prepare for the next market turmoil.
Stewart shared, “For many, if not all firms, collateral settlements are currently not acknowledged in real time. Confirmation of collateral settlement may take one to two days, by which time, a failed trade may already have happened. Firms need to automate instructions on settlement clearance for every collateral – to improve efficiency in the management of capital and liquidity.”
The market turmoil that we witnessed in 2020 is a wake-up call for firms to seriously consider working with third-party vendors to automate and streamline margin call processing and the communication of collateral settlements – to reduce operational risk, Stewart emphasized.
Stewart urged firms to capitalize on the upcoming UMR requirement to adopt industry best practices in managing collateral as well as increase efforts to automate their collateral management and settlement tracking processes.