Bylined Articles

Oct 03, 2016 • Bylined Articles

All Change: Revamping the Collateral Management Process

By Ted Leveroni, Executive Director and Chief Commercial Officer, DTCC-Euroclear Global Collateral Ltd.

All Change: Revamping the Collateral Management Process

Ted Leveroni, Executive Director and Chief Commercial Officer, DTCC-Euroclear Global Collateral Ltd.

With new regulatory requirements around collateral and margin obligations coming quickly, it is easy to understand why many firms are taking a tactical approach to compliance. But this could result in a missed opportunity to transform a critical business process. The benefits of optimizing collateral management include enterprise-wide control and visibility of collateral resources, leading to more efficient risk, liquidity and balance sheet management; improved decision-support for trading and investment decisions; reduced back-office costs; and greater flexibility to evaluate and meet client demand.

With new regulatory requirements around collateral and margin obligations coming quickly, it is easy to understand why many firms are taking a tactical approach to compliance. But in some instances, this could result in a missed opportunity to transform a critical business process, which could drive even greater efficiency, competitiveness and customer value in the longer term. In particular, there are strong grounds for taking a strategic approach to compliance with the various collateral- and margin-related rules – primarily but not exclusively related to those reforms impacting the OTC derivatives markets – that are beginning to mandate how firms must manage their collateral resources.

While important in their own right, regulatory reforms can also provide a catalyst for firms to adopt a more coordinated approach to collateral management operations to propel improved capital and risk management, as well as deliver new opportunities to meet client requirements more cost effectively.

Historically, compliance often has been regarded as an exercise to provide greater transparency to regulators, with little additional value to the business. In recent years, this approach has evolved, with compliance considerations factored into many aspects of how banks, broker-dealers and their buy-side counterparts do business.

Nevertheless, the sheer range of incoming regulations means firms are fighting fires on many fronts with limited resources, thus increasing the temptation for short-term fixes. Moreover, the frequent delays and revisions to new rules encourage banks to take a more tactical, flexible approach, diverting resources between compliance projects.

And with revenue forecasts thrown into question by all manner of factors – from sustained low interest rates to geo-political uncertainties to balance sheet constraints – many firms are keen to achieve compliance as cost-effectively as possible and with as little disruption to clients.

But piecemeal process re-engineering can be painful. The problem with tactical, short-term fixes, of course, is that they are temporary measures that are blind to future developments; they are unlikely to form the building blocks of a future solution, and may have to be replaced in the long term, often proving to be very costly.

Today’s Manual, Fractured Environment

Until recently, collateral management has been a somewhat fragmented and under-invested activity. On the one hand, many sell-side back-office teams have persisted with highly manual processes, unless prompted by regulatory mandate, such as in the interbank IRS market. On the other, responsibility for managing sell-side firms’ collateral resources is often balkanized based on the needs of individual business lines, resulting in the absence of firm-wide visibility, control or investment.

All Change: Revamping the Collateral Management ProcessFor banks, central treasury, securities lending, repo and derivatives businesses may all be involved in paying or receiving collateral on any single day to meet needs from intra-day funding to client facilitation. But so diverse and siloed are these activities that any efforts toward greater coordination and efficiency simply broke down. Meanwhile buy-side firms have been somewhat shielded by the support of their sell-side counterparts, which have been extremely flexible in the quality and timeliness of the collateral they require in support of OTC swaps trades, for example.

Now, the hand of coordination and efficiency has been strengthened by regulation. Not only is a more structured approach sensible and efficient, it is encouraged by regulatory change. Moreover, harmonized global rules enable standardized market participant processes. And it’s not just derivatives market reforms that are driving firms to develop frictionless and robust collateral management processes. Basel III’s new capital and liquidity regime requires banks to be more disciplined in managing their resources, including collateral assets, while also encouraging them to be less flexible in the terms offered to their buy-side counterparts, which also are under greater scrutiny due to best execution regulations, related to the efficiency, transparency and independence of their trading and investment operations.

A further reason to take a strategic approach to collateral management is that the sheer weight and scope of the changes being wrought by regulatory reforms has mobilized suppliers, from technology vendors to custodians to market infrastructure providers.

Some of the most-dire predictions of collateral shortfalls over the past five years have yet to materialize, but a combination of macro-economic and regulatory forces continues to make high-grade collateral more scarce and in greater demand. As such, long-standing barriers to efficient collateral management are being dismantled and new initiatives are being constructed to ease future flows.

The Way Forward

Much of the work required to implement a more coordinated, holistic and automated approach to collateral management will be internal, dictated by legacy systems and prevailing business priorities; but a number of developments are making it easier for firms to overcome traditional barriers. Indeed, the level of external expertise available to improve collateral management processes is unprecedented.

Technology providers, for example, have made significant advances in providing aggregated, timely information on collateral availability, as well as increasingly automated means for conducting collateral-related processes, such as margin calculation and dispute resolution, applying industry-level standards wherever possible to facilitate interoperability. But the process automation and harmonization increasingly achieved by collateral management and related systems is not possible without industry-level collaboration to develop consensus on market practice and message standards.

Similarly, custodians and central securities depositories have developed new service propositions aimed at enabling firms to gain easier access to collateral assets held across multiple jurisdictions, while maintaining their responsibilities for safe-keeping. At the same time, utility-based solutions based on standardized processes and common needs, are helping market participants handle the heavy lifting and day-to-day processing challenges of a complex and still-evolving collateral environment.

Tactical or strategic, each firm must take the path most suited to its business needs. But industry and regulatory drivers mean that there has never been a better time to overhaul collateral management arrangements and take advantage of new innovations and service propositions. The potential upsides are substantial: enterprise-wide control and visibility of collateral resources, leading to more efficient risk, liquidity and balance sheet management; improved decision-support for trading and investment decisions; reduced back-office costs; and greater flexibility to evaluate and meet client demand, to list but a few.

Moreover, because many of these solutions and initiatives are being informed by collaborative working groups, this period of unprecedented activity in the collateral management space offers market participants the chance to shape these solutions in line with their own evolving needs. Collateral management is no longer a discreet process – it is a multi-dimensional upstream/downstream multi-asset business. It’s time to start treating it as such.

This article first appeared in TABB Forum on September 27, 2016.

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