Buy Side Hones In on Collateral

Terry Flanagan

The buy side is focused on collateral management as a result of concerns over how to address operational and counterparty credit risk while navigating the changing regulatory landscape.

The Basel Committee on Banking Supervision and the International Organization of Securities Commissions (Iosco) issued on September 2 the final framework for margin requirements for non-centrally cleared derivatives.

Under the globally agreed standards, all financial firms and systemically important non-financial entities that engage in non-centrally cleared derivatives will have to exchange initial and variation margin commensurate with the counterparty risks arising from such transactions.

The framework has been designed to reduce systemic risks related to over-the-counter (OTC) derivatives markets, as well as to provide firms with appropriate incentives for central clearing while managing the overall liquidity impact of the requirements.

“The extent to which the margin requirements will disincetivize banks from having this as a business model or otherwise raise initial margin levels is something the buy side needs to pay attention to,” said William Thum, principal at Vanguard Group, at Thursday’s Isda North America Conference in New York. “We need to consider the extent to which the buy side should play a role in navigating these rules.”

The framework exempts from initial margin requirements the fixed, physically settled FX transactions that are associated with the exchange of principal of cross-currency swaps. However, the variation margin requirements that are described in the framework apply to all components of cross-currency swaps.

It envisages a gradual phase-in period to provide market participants with sufficient time to adjust to the requirements. The requirement to collect and post initial margin on non-centrally cleared trades will be phased in over a four-year period, beginning in December 2015 with the largest, most active and most systemically important derivatives market participants.

Central securities depositories are emerging as linchpins in the optimization of collateral, which is being mandated by the need to increase working capital in a post-Dodd-Frank and Emir world.

Singapore Exchange (SGX) and Clearstream have signed a Letter of Intent on the launch of a collateral management service which enables customers to more easily and efficiently use assets held at SGX’s securities depository, CDP, for their collateral needs.

Under the agreement, SGX uses Clearstream’s collateral management infrastructure, the Global Liquidity Hub, and offers its Liquidity Hub GO service, to enable collateral to be allocated, optimized and substituted on a fully automated and real-time basis. Singapore’s market infrastructure remains strong as the service ensures collateral remains within domestic jurisdiction.

“We are pleased to partner with Clearstream in providing our customers a collateral management offering which meets their needs at a time when they are increasingly concerned about risks and regulatory changes,” said Muthukrishnan Ramaswami, president of SGX. “We will also work with Clearstream to expand this offering to other markets in the region.”

Clearstream’s Liquidity Hub GO service went live with the Brazilian CSD Cetip in July 2011 and will be launched with ASX, Australia, the South African CSD Strate and Spanish CSD Iberclear in the course of 2013. Canadian CSD CDS has also signed a Letter of Intent with Clearstream.

Two of the world’s largest central securities depositories, DTCC and Euroclear, are collaborating on a service to provide transfer and segregation of collateral based on margin calls relating to OTC derivatives.

The joint service will be operated as an industry cooperative and will provide open and non-discriminatory access to all other collateral processing providers, including custodians, CSDs and ICSDs that wish to link their services to the service.

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