Ted Leveroni, Executive Director, Business Development and External Relations, DTCC
The availability and optimal use of collateral continues to be a key focus of market participants’ risk management processes, as a result of the global financial crisis and an onslaught of new mandates. Firms in Asia, like their global counterparts, are putting measures in place to strengthen their collateral management processes as a result of two major pieces of regulation: over-the-counter (OTC) derivatives reform and enhanced capital and liquidity requirements under Basel III regulation.
Under G20-led reforms, increasing global regulation has created fundamental challenges to existing operating models for market participants that trade OTC derivatives, particularly in Asia, due to market fragmentation resulting from multiple central counterparties (CCPs) and different jurisdictional regulations. According to the International Swaps and Derivatives Association’s (ISDA) most recent study about the Asian OTC derivatives market, Asia comprises 8 per cent of global OTC derivatives transactions and the association estimates that collateral requirements in the region can be expected to be in the range of $80-$160 billion.
These operational challenges that come with that level of collateral demand will be exacerbated by the shortage of acceptable assets in Asia that are needed to meet these increasing collateral requirements driven by central clearing, as well as the higher margin requirements for OTC trades that continue to be non-centrally cleared. As a result, firms are becoming increasingly aware of the need to increase efficiencies in the deployment of available collateral.
Across the Asia region, policymakers have recently introduced new rules and regulations which detail the collateral requirements for firms trading OTC derivatives, such as the amendments to the Financial Instruments and Exchange Act in Japan (2014), the Securities and Futures Ordinance (2014) in Hong Kong, the Securities and Futures Act (2012) in Singapore, and the Corporations Legislation Amendment Bill (2012) in Australia. These efforts complement a wide range of US and European regulations governing the use of derivatives such as the Dodd-Frank Act and the European Market Infrastructure Regulation (EMIR) respectively.
It is not just global OTC derivatives regulations that will change the way firms manage their risk and associated collateral. For the sell-side in particular, one of the biggest impacts on collateral management processes is likely to emanate from Basel III regulation. Firms will be required to hold high quality liquid assets (HQLA) to meet the requirements of the Basel III Liquidity Coverage Ratio (LCR) thus locking up instruments that could otherwise be used as collateral.
The success of each of these regulations, whose goals are increasing market stability, enhancing transparency and reducing counterparty, operational and liquidity risk, will, however, be largely dependent on the efficient management and effective processing and allocation of collateral. What has become clear is that the evolving Asian markets increasingly require sophisticated solutions that help to manage collateral across jurisdictions and a complex network of multiple clearing brokers, CCPs and bilateral counterparties in addition to other operational relationships.
A large number of firms, however, are still using antiquated, manual processes and fragmented systems to manage their collateral. Indeed, too often, collateral is managed in siloes across an organisation, sometimes making it impossible to have a holistic view of what and where collateral is in use which makes managing and processing collateral inefficient and costly.
In fact, a recent academic study published in June 2014 by The Depository Trust & Clearing Corporation (DTCC) and the London School of Economics (LSE) highlighted the increasing occurrence of collateral bottlenecks due to weaknesses in financial market infrastructure. These weaknesses lead to eligible collateral being immobilized in one part of the system making them unattainable to credit worthy borrowers who need access to their inventory of collateral not only for central clearing purposes and higher margin requirements for bilateral transactions, but to track and optimize their available collateral. Furthermore, the ability to successfully analyze the collateral implications of a trade before it is executed allows for more efficient management of available assets.
Financial institutions are becoming increasingly cautious of fragmented, siloed methodologies that can only deliver limited operational cost and risk benefits and will, ultimately, leave firms struggling to comply with future regulations. Instead they are seeking to partner with market infrastructures to bring efficiency to their collateral processes, enabling them to remain competitive, effectively leverage all of their collateral and drive down costs. To meet that objective, a joint venture between DTCC and Euroclear (Global Collateral Limited) has been established to not only address operational and counterparty risk, but also the broader issue of systemic risk by providing greater transparency of collateral availability and mobility.
Global institutions, from both the sell and buy sides, are increasingly looking to the Asian markets as a source of growth. At the same time, many smaller market participants based in the Asia region are looking outside their domestic markets to compete internationally. Increased international trade, however, brings with it greater regulatory complexity. As a result, the ability to seamlessly implement collateral processes across asset classes and borders will be critical to success.
"Constant challenges, new solutions," Asset Servicing Times, February 2015