Global regulations and changing market dynamics are mandating new and complex requirements for the use of collateral, which are forcing both sell-side and buy-side firms to reevaluate their need for and use of collateral.

Mandatory clearing of OTC derivatives transactions has dealers and swap participants scrambling to marshal their assets to meet collateral obligations, a process known as “collateral transformation.

Collateral transformation is a form of collateral optimization – which is making sure that collateral is allocated as efficiently as possible, and the process will include swapping bad collateral for good collateral. If properly optimized, the lowest acceptable grade collateral is pledged, working from worse to best.

Many of the big custodian banks such as State Street and Bank of New York Mellon are currently looking at providing collateral transformation services, alongside their custodial collateral management offering.

“Studies have shown that the move to centrally-cleared derivatives will result in a collateral shortfall of up to $2 trillion,” said James Slater, executive vice president at BNY Mellon Global Collateral Services, during a panel discussion on financial markets reform sponsored by Markit this week. “Firms therefore need to optimize their use of collateral. Dealers and banks have a good idea how to do this. Now the onus is on the buy side to come up with a solution, especially since they have collateral across multiple providers.”

BNY Mellon formed Global Collateral Services in 2012 to serve broker-dealers and institutional investors facing rapidly expanding collateral management needs as a result of regulatory and market requirements.

Global Collateral Services brought together BNY Mellon’s capabilities in segregating, allocating, financing and transforming collateral, including its broker-dealer collateral management, securities lending, collateral financing, and liquidity.

“By pulling all of those services together under one umbrella, we can become more nimble at addressing collateral issues raised by new regulatory and market developments,” Slater said.

BNY Mellon currently services $2 trillion in global collateral, and operates one of the industry’s largest securities lending programs, with $3 trillion in lendable assets.

Buy side firms are faced with the need to achieve collateral efficiency and optimization in the face of Dodd-Frank and Emir, with 67% of firms stating as “most significant” the need to clear and collateralize in a manner that maximizes portfolio netting, according to a Celent report.

“Operational readiness has risen to the top of the agenda for our clients,” said Karoline Kane, managing director at JP Morgan, during the panel discussion. “We have organized all our collateral services under one umbrella. We have started to think about collateral as a product: What services do we need to provide both internally and to clients, such as margin call management and dispute resolution?”

JP Morgan’s collateral series include CSA (credit support annex) management to ensure client exposure is adequately collateralized with eligible assets; margin management, including issuing margin calls to relevant counterparties when the client is exposed and thresholds have been breached, and validation and action on counterparty margin calls; and automated OTC portfolio reconciliation, essential to the effective management of risk and central to the resolution of disputes between clients and counterparties.

BNY Mellon has upgraded its AccessEdge collateral management portal via a link to Pirum’s tri-party automation service to enhance clients’ ability to manage collateral.

The benefits of the new link include improved intraday visibility of proposed trades, simpler and timelier trade resolution management, and a single unified process for the agreement and communication of trades.

“Complexity is often added with the need to segregate collateral at a final beneficial ownership level on a timely basis,” said Staffan Ahlner, managing director at BNY Global Collateral Services, in a statement. The new link is a step in the overall plan to enhance the connectivity of BNY Mellon’s tri-party system to lenders and borrowers.”