Ted Leveroni, Chief Commercial Officer of DTCC-Euroclear GlobalCollateral Ltd.
Collateral and the role it plays in ensuring the smooth functioning of capital markets is nothing new. Amidst an evolving global post-crisis regulatory and macro-economic environment, firms have been making gradual enhancements to their collateral management processes, moving it from a back-office administrative function to an essential part of trading, liquidity management, credit risk and market risk processes.
But we are now on the precipice of fundamental change as firms come to realise that more needs to be done. Automation, a buzzword in recent years, is no longer the only means to enhancing collateral management processes. Adoption of messaging standards and the use of collaborative infrastructures will also be important requisites to ensuring risk mitigation in financial markets.
Collateral management has recently reached the top of the agenda for buy-side firms, who now have to take responsibility for processes and procedures that they previously left to their banks and brokers. For investment managers in particular, changes have been brought about mainly as a result of OTC derivatives regulatory reform worldwide. One of the biggest changes is the introduction of central clearing which has meant that an investment manager would no longer face off against a broker from a credit and counterparty risk perspective. Instead, the counterparty risk for each transaction is now assumed by a clearing house in return for the posting of collateral by the investment manager. In the U.S., central clearing has been underway for buy-side firms for some time while in Europe we expect to see similar mandates implemented towards the end of next year. Looking further afield to Asia, regulators are following closely behind.
For those contracts not standardised enough to be centrally cleared, increased margin requirements under the policy framework of BCBS-IOSCO, will soon enter into force. Starting from September 1, 2016 through to September 1, 2020, investment managers will be required to post both initial and variation margin, with variation margin calls subject to minimum transfer amounts on a periodic basis. In fact, recent comments from Scott O’Malia, CEO of ISDA, suggest that the new margin rules for non-centrally cleared derivatives are the most important change for the industry since master agreements were put in place 30 years ago.
According to a recent study by Aite Group, commissioned by GlobalCollateral Ltd., a third of buy-side firms are concerned that new regulations will increase the cost of collateral and clearing services might reaching the tipping point where some brokers may be less willing to offer such services. By leveraging a common global collateral infrastructure that is built on extensive cross-border industry engagement and able to service the needs of a broad range of market participants, firms are able to reduce the operational costs and risks associated with their collateral processes while, at the same time, complying with increased regulations. Moreover, the ability to leverage ideas and experiences generated from an external solution provider’s entire client base, not just a single firm’s internal pool of experts, has other obvious benefits.
Furthermore, the collateral lifecycle does not end within one firm’s four walls. Instead, it spans multiple parties and counterparties. Given that much of the collateral process is based on communication, data delivery and collateral movements between different entities, it makes good sense to leverage standards and adopt solutions as a community, rather than implementing firm-specific solutions. This also allows buy-side firms to commit more resources to focusing on their core competencies of managing investor portfolios.
There has certainly been more collaboration between industry participants over the past year than we have ever seen before but our work isn’t complete. Looking ahead to this week’s Sibos conference, it will be interesting to meet with market participants, partners and colleagues to further develop that collaborative thinking, gaining further insight into how market infrastructures can broaden their support for the industry to further reduce costs and risks while increasing operational efficiencies.
This article first appeared in Futures & Options World on October 12.
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