Collateral Management Becomes Core Competency

Terry Flanagan

The use of and optimization of collateral has been given impetus by regulations that require most OTC swaps transactions to be executed and cleared.

“The theme of regulation will be to manage systemic risk by monitoring items at a more granular level,” said Chris Momsen, executive vice president of global sales and solutions management at Advent Software. “While this is a valid exercise, it will present challenges to market participants.”

First, more counterparty relationships and interconnectivity will ensue and that necessitates time and resource devotion. Second, on the operations front, firms will now have to instruct, monitor and reconcile with more counterparties at a more specific level than many are currently able to do.

“Thematically, this means a higher effort for firms seeking to optimize their use of collateral,” Momsen said. “This optimization helps a buy side firm maximize its buying power and helps banks maintain optimal leverage ratios to comply with Basel III, for example. So, obviously, this is important to all parties.”

The fact that not all swaps will be cleared presents its own set of challenges, as buy side firms and their counterparties will need to keep track of collateral for both cleared and uncleared swaps.

This was driven home by the Commodity Futures Trading Commission, which on Thursday issued a rule governing the protection of customer funds when entering into uncleared swap transactions.

Swap dealers will be required to give each of their counterparties the choice with regard to segregation of collateral, and dealers also will have to provide prices for the various segregation choices. Further, dealers must give the customers at least one custodial arrangement choice not affiliated with the swap dealer’s bank.

In addition, the rule provides clarifying changes to ensure that if a counterparty chooses segregation for its funds, those funds will not be tied up in the bankruptcy of its swap dealer.

“Today’s final rule fulfills Congress’ mandate that counterparties of swap dealers be given a choice regarding whether or not they get the protections that come from segregation of monies and collateral they post as initial margin,” said CFTC chairman Gary Gensler. “These are important customer protections for counterparties as they enter into customized swaps with swap dealers.”

Meanwhile, Friday, November 1, is the CFTC’s compliance deadline for SEFs to complete onboarding documentation and provide pre-trade credit check functionality. The deadline was originally October 2, before a last-minute extension from the CFTC.

“In the first month of SEF trading, more than $280 billion in cross asset volume has been executed on our SEF and over 220 global firms – inclusive of the major liquidity providers – have signed our rulebook,” said Ben Macdonald, Bloomberg’s head of product and president of Bloomberg’s SEF. “We will continue to work closely with our clients, who have used our trading platforms for years, to help them transition to today’s new regulatory environment.”

Bloomberg’s SEF facilitates pre-trade clearing certainty for interest rate swap and credit default swaps. Additionally, Bloomberg recently developed new technology to enable buy-side investors to combine smaller sized trade orders into a single block for “bunched” clearing. After the trade is executed and cleared, it is then allocated across multiple accounts. MKP Capital completed the first-ever bunched trade via Credit Suisse on Bloomberg’s SEF last week.

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