Article: Collateral Management Infrastructure: 10 Reasons You Need to Invest06 April 2015 | Ted Allen
So many activities which used to be outside the view of regulators now fall squarely under a supervisory search light, that firms have to continue to invest in their systems, people and procedures to stay still. Something simple like portfolio reconciliation used to be a sideshow, but is now required and monitored with capital charges hitting miscreants. With further regulation coming down the pipe in the form of Leverage Ratio, rules governing margin on bilateral (non-cleared) OTC business and others, firms must think ahead and have budget available to adapt to these new rules.
The Drivers for Change
I’ve picked ten major reasons to consider your investment budget in collateral management, some which are causing an impact now, and some which could be major drivers of change in the near future. I would be interested to hear from readers which of these they regard are the most pressing needs for their firms, get in touch after you’ve read these through.
1. Blurred Lines: With the arrival of hybrid swap futures from CME and Eurex, and possibly more to come – you may find your software unable to manage the risk on those products. From a trading point of view these are futures, but the underlying risk is an OTC Rate Swap. If your front office aren’t already trading these, they may do soon, as the margin requirement on the underlying IRS is calculated using a one or two day holding period, rather than five at most CCPs.
2. Cross-margining: Eurex and CME both offer an approach to picking futures positions which reduce the Initial Margin requirement on your cleared OTC swap portfolio. The effect of this is to transfer futures into the OTC swaps margin calculator and default management process, leaving your futures back office without any need to reconcile the margin on those positions.
3. Call frequency: Given the regulatory focus on clearing and margining, many firms are finding themselves having to support daily margin calls, something new for smaller firms. This means the collateral management teams must be capable of updating portfolios, agreements, trade valuations, asset valuations and custody holdings every night.
4. Variation Margin per currency: For cleared business, and for some un-cleared business, the variation margin needs to be calculated, called and funded in the underlying currency of the portfolio. Clearing houses only work this way, and for the alignment of funding costs, some bilateral business is moving this way, for instance ISDA proposed the wholemarket move to this model, but regulatory events have overtaken that initiative.
10. Bilateral margin rules: This topic alone justifies a review of your collateral management platform, and will be the next major change for many users of OTC products. Regulations in the US and EU are targeting December 1st 2015 for firms to begin applying a new model of Initial and Variation Margin to un-cleared OTC portfolios. The rules exist in draft form but in summary require VM per currency, daily margin calls, IM by asset class, a VaR or schedule based approach to IM, splitting of your existing CSAs and potentially back-loading of trades into your new CSAs post- Dec 1st.
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