Margin Issues Vex Buy Side

Terry Flanagan

New clearing mandates hike demand for collateral optimization techniques.

New regulations mandating that OTC derivatives be centrally cleared are placing a burden on end users, who have historically been used to dealing with non-centrally cleared OTC swaps but now face new requirements in the form of increased margin and collateral.

“We’re seeing increased demand not only for collateral management software, but for collateral optimization solutions,”  David Little, director of strategy and business development for securities finance and collateral management at Calypso, told Markets Media.

The role of collateral management is moving to the front office based, where real-time collateral analysis and inventory management is required to drive investment decisions, said Little, who he helped to design and launch one of the industry’s first commercially-viable collateral optimization products.

“As firms become more concerned with funding and transaction costs, the ability to automate and optimize collateral management becomes critical,” Little said.

That’s spurring demand for services aimed at simplifying the collateral process in order to help clients avoid the associated funding costs and increased complexities.

“There is a need for the buy-side to move from cash to non-cash collateral,” Little said.  “Why? Estimates of the amount of initial margin that will be charged range from $1-2 trillion. If the buy-side use cash to pay their IM contributions, that’s a lot of cash to mobilize which will have to be raised by liquidating part of the portfolio, impacting fund performance.”

It makes more sense to use the assets in their portfolio, he said. But that demands a change in business practice, and if they don’t happen to be invested in CCP-eligible securities, then there is a need to transform collateral.

“The sell side are preparing to offer collateral transformation services,” said Little.

While initial margins are already a common practice for hedge funds, the DFA regulation, as per its current progression, will likely drive the majority of users of OTC derivatives to post initial margins to their counterparties – a practice they are not used to.

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