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With pending regulatory changes, the volume of bilateral OTC derivative collateral movements is expected to increase. And with a related volume spike, the number of collateral settlement fails and associated costs are likely to rise proportionally, according to the white paper, Implications of Collateral Settlement Fails.

Consequently, if the current 3% settlement fail rates for collateral movements continue, the white paper suggests that the operational cost will become unsustainably burdensome, especially for buy-side firms.

It is imperative that the industry understand the current collateral settlement fail remediation process and the underlying costs, the paper reports, as well as the future impact of collateral settlement fails. In addition, it is necessary to determine whether an investment in operational and technological redesign is warranted.

Related: Mark Jennis, Executive Chairman and Ted Leveroni, Chief Commercial Officer, DTCC-Euroclear GlobalCollateral, talk about the implications of collateral settlement fails and the industry solution. View videos:

Reconciliation and Identification of Fails

On an intra-day or daily basis, participants match the trade population against the expected values in a collateralized portfolio. Once reconciliations are performed, participants identify breaks in their bilateral records; these breaks are flagged as collateral settlement fails.

Internal Research

Participants analyze the identified collateral settlement fails and perform a root cause analysis. This analysis requires communication between the front, middle, and back office. It is possible for a fail to be remedied at this stage if the identified collateral settlement fail is caused by an internal error (e.g., incorrectly entered SSI information).

External Communications

If the root cause of the collateral settlement fail is attributed to an external source, participants may need to collaborate with their counterparty, client, and/or custodian. This communication enables participants to re-confirm trade details and understand where collateral is physically located. Through external communications, a participant may gather pertinent details giving them visibility into why the counterparty was unable to post the required collateral in the allotted time.

Furthermore, a participant may come to an agreement with the counterparty to remedy the collateral settlement fail. Most collateral settlement fails are remedied at this stage. Participants are only as strong as the weakest link in their collateral settlement chain; a participant that has a low fail rate may still spend a substantial amount of time remedying fails if their counterparty consistently has issues and requires additional communication. Additionally, small buy-side firms have identified counterparty unresponsiveness as a challenge when resolving issues and collateral settlement fails. The extended delay in communication leads to higher than average time spent on external communication.

How Collateral Fails Occur

The three instances of a collateral fail are: The collateral is delivered to the wrong account; it goes undelivered; or the wrong collateral is used.

Remediation and Escalation

According to interviewees, collateral settlement fails are remedied, on average, within two business days. If a collateral settlement fail is not remedied in that normal timeframe, the fail is likely to be escalated to management for remediation. Further escalation can reach senior management or relationship managers. The majority of collateral settlement fails do not require management intervention. However, for the fails that are escalated, the cost associated with each is inherently higher than those remedied earlier in the process due to the engagement of senior and relationship management.

In order to avoid the cost associated with performing these remediation tasks at exponentially increased levels in future (due to the anticipated increased volume of collateral movements), market participants should look to increase STP to limit operational costs and provide greater visibility into one’s operations.



Implications and Costs of Bilateral OTC Derivatives Collateral Settlement Fails

Four Themes of Collateral Settlement Fails

The True Cost of Collateral Settlement Fails