Collateral Management Causes Big Headache

Terry Flanagan

Collateral management has become a front-burner issue for banks active in the OTC derivatives markets, and many executives fear a collateral shortfall will hit as early as 2015, according to a study by post-trade services provider SIX Securities Services.

The study, ‘Collateral Management: How Collateral Values Can Prevent The Next Crisis’ highlights the views of senior figures responsible for collateral management at 60 leading financial institutions in the U.K., France and Germany.
“The race for collateral is only becoming more intense,” said Robert Almanas, managing director for international services at SIX Securities Services. “Those firms which equip themselves with real-time, tailored collateral management systems stand the best chance of success.”

Stricter eligible collateral parameters, steeper haircuts and increased margin requirements are major factors forcing firms to re-evaluate how collateral is pledged to satisfy clearinghouses and regulators, according to Jeff Campbell, director and head of the collateral management Practice at Actualize Consulting.

“Each firm must take steps to corral all assets across the firm and manage them from one central location,” Campbell said in a blog posting. “CCP same-day settlement window requires collateral to be the right type, in the right place and at the right time. This is a daunting task as not all needs can be anticipated in advance, and virtually impossible if a firm’s assets are not aggregated properly.”

In its most basic form, optimization aggregates all the firm’s assets, and then intelligently pledges those assets to counterparties based on any number of variables, such as a firm’s associated “cost” they assign to that asset, said Campbell.

As most firms don’t have a “global” view of all assets throughout an organization, collateral pledging would otherwise be sought through repo or securities lending arrangements to procure high-grade collateral while perfectly acceptable assets would continue to remain dormant.

Three-quarters of respondents to the SIX Securities Services study believe collateral management has become, or is at risk of becoming, a commodity, while 48% think that securitizing and repackaging existing collateral portfolios to create new collateral pools will sow the seeds of the next financial crisis.

“The collateral lockdown brought about by Dodd-Frank, EMIR and Basel III means collateral management – for so long consigned to the back office – is now an issue of board-level concern,” said Almanas. “Good collateral management is not just about keeping an institution’s operations as efficient as possible but ensuring that they are also simpler and more secure than in the past.”

More than a third (38%) of respondents believe that the most important requirement of a collateral management system is that it covers central counterparty acceptance, compared with just 2% who say cost.

Most firms (73%) are currently using a tri-party collateral management system. The majority of those using a tri-party system say it offers reduced risk, ease of use due to processes being more automated, and a reduced cost because of a reduction in time spent on collateral management. Tri-party collateral management systems are also becoming increasingly coveted for their ability to safely ring-fence an institution’s assets.

“When deciding upon a collateral management provider, firms should look to a wide range of variables including knowledge of local markets, real-time counterparty risk exposure, quality of the on-boarding process and multi-geography, multi-currency, multi-asset class functionality,” Almanas said.

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