With a major U.S. clearing deadline approaching, buy side firms are seeking to transform their derivatives operations, with a focus on collateral optimization.

Swap dealers, major swap participants and private funds active in the swaps market have all been required, from March 11, to begin clearing certain index credit default swaps and interest rate swaps.

All other financial entities will be required to clear swaps beginning on June 10, 2013, for swaps entered into on or after that date. Buy-side market participants transacting swaps must determine whether they are subject to the mandatory clearing requirement.

The possibility that every OTC relationship may need collateral accounts under new regulations has driven demand for more efficient services to streamline the technical and operational challenges of managing all types of collateral assets across multiple counterparties.

“Prior to going live, firms need to run parallel test systems to make sure that everything is feeding properly downstream from a regulatory and internal risk perspective,” said John Griffin, senior risk manager at The Hartford Investment Management Co. (Himco). “We have done our first live trades for test purposes prior to the mandatory go-live date, and while there are a lot of moving pieces, we are confident that everything will be working properly as envisioned.”

The possibility that every OTC relationship may need collateral accounts under new regulations has driven demand for more efficient services to streamline the technical and operational challenges of managing all types of collateral assets across multiple counterparties.

“As the buy side undertakes implementation efforts towards derivatives clearing and collateralization reforms, the impact to business and operational strategies of investment managers, hedge funds, insurance companies, and pension funds is now beginning to crystallize,” said Celent research analyst Cubillas Ding in a report.

From a technological standpoint, collateral optimization required cutting-edge technology to identify, prioritize and deliver the lowest grade of accepted collateral across an entire organization.

Many firms are looking for margin efficiency gains to be achieved at the CCP ;eve; via portfolio margining, according to Celent, and via their clearing brokers, which also can provide cross-product margining between cleared and non-cleared trades.

Buy side counterparties to cleared swaps and non-cleared OTC deals under new regulatory regimes expect to be subjected to higher financial and operational costs, with the cost of collateralization expected to increase by up to 20%, said Celent.

This increase in driven by additional initial margin (IM) requirements, credit costs associated with sourcing eligible collateral (e.g., cash and U.S. Treasuries), and operational infrastructure to manage more complex requirements associated with Dodd-Frank, Emir, and similar regulatory regimes.

The Basel Committee on Banking Supervision (BCBS) and the International Organization of Securities Commissions (Iosco), in a consultation paper on margin requirements for non-centrally-cleared derivatives released in February, are proposing that all financial firms and systemically-important non-financial entities that engage in non-centrally-cleared derivatives must exchange initial and variation margin as appropriate to the risks posed by such transactions.

Only 28% of firms surveyed by Celent claimed they were fully operational in terms of implementation efforts for OTC clearing and collateralization.