Article: Getting It Right (Collateral and Custody)25 September 2018 | James Cherry
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New regulation, the advent of the Central Counterparty, a shrinking repo market, historic low interest rates. At the same time the rapid emergence of new financial technology and the trend towards "datafication". These are all factors that contribute towards the ever increasing focus on collateral management, specifically on "getting it right", and getting it right all the time.
OTC Derivative regulation has already massively increased demand for eligible collateral, while the Liquidity Coverage and Net Stable Funding ratios have increased scrutiny over and management of, the quality and maturity of securities held on balance sheet. Regulatory pressure to hold customer and proprietary assets in segregated, rather than omnibus, accounts has further contributed to the complexity of mobilizing and using collateral.
Market participants increasingly manage and optimize the sourcing, transformation and allocation of collateral across multiple parallel streams, with multiple product and asset classes in play across both cleared and uncleared, bilateral and triparty environments.
A well-documented theme in the collateral management space has been banks taking a more holistic, systematic approach to collateral management. The operational, risk management and economic benefits of managing collateral centrally is well established among the sell-side community. Similarly a number of factors have contributed to the rising importance of collateral management with the hedge fund and wider buy side community and with a mounting regulatory burden (key dates such as Sep 2019 and 2020 for initial margin compliance), an increased cost of accessing financing from, and the use of multiple, prime brokers there has never been more focus on the importance of getting collateral management right.
ISDA expect dealers to face an estimated 1,000 Newly In-Scope Counterparties (NISCs) and 9,400 new relationships in the final phase of 2020
Clearstream’s OTC Collateral service helps customers meet these challenges by enabling them to cover all their derivative and other bilateral exposures from a single collateral pool whilst at the same time ensuring regulatory compliance and benefiting from the economies of scale, a provider already managing EUR 650bn of collateral and EUR 14 trillion in assets under custody can offer.
New margin requirements in relation to derivatives create significant operational challenges, driving firms to re-evaluate current processes and workflows. Such challenges include;
- Variation margin: Mandatory collateralization, daily margin call calculation and zero thresholds drive up margin call volumes significantly
- Initial margin: Daily collateral valuation, margin call exchange (gross basis) and segregation at a non-affiliated third party custodian or triparty agent, rehypothecation / reuse of margin is not permitted
- Clearing House: Multiple possible account structures, netting efficiency considerations, multiple types of collateral usage, daily margin call calculation and zero thresholds, challenges of managing a dual Cleared and Bilateral margin workflow process
- Eligibility requirements (i.e. eligible collateral and haircuts, concentration limits, maintenance of large reference data sets) basis between different regulators, stringent Minimum Transfer Amounts applicable to both variation margin and initial margin
- Parallel streams for legacy and regulatory variation margin and, if in scope, initial margin calls vs. the same counterparty, along with the associated legal and documentation challenges
- Strain on daily operational workflows driven by a hike in call volumes and greater complexity, often combined with earlier notification deadlines and shrinking settlement windows
All of the above are clearly very complex to manage and can involve the use of up to 5 internal and external (vendor) solutions and processes. Manual processes are cumbersome and risky. Further whilst the above can be key influences of trading strategy and risk management they can at the same time be an unwelcome distraction from it.
Margin requirements for OTC derivatives alone have created a substantial additional workload for the middle and back-office areas. Indeed, the hike in the number of calls to manage with counterparties along with increased complexity and timing pressures are a strain on manual processes which themselves become a source of operational risk and additional cost. This is further exacerbated in the case of structures with underlying funds under management where collateral needs to be segregated at a fund level. Furthermore, for much of the buy side managing collateral workflows is often not the core activity of the teams involved and their capabilities can be put to better use.
Clearstream reduces the burden by taking on all the administrative tasks involved with collateral management, thereby freeing valuable resources for strategic, value added tasks.
Facing the challenge
Inefficiencies and costs are inherent with outdated organisational models. Eventually, firms need to weigh the benefits of internalizing processes versus using the outsourced solutions of collateral agents or a combination of both. When internalizing, product and process complexity and trade/call volumes must be considered both directly but also in alongside the implied resource deployments, training, technology developments and maintenance, licencing arrangements, data management across assets classes, eligibility profiles, settlement locations etc. Simply put multiple layers of varying complexity and shifting dynamics are almost impossible to control, outsourcing to a full service solution such as Clearstream allows a firm to cap, control and budget with confidence.
Secured access to liquidity
A main concern notably for many buy-side firms, is to maintain access to liquidity within the aforementioned challenging environment. Developing trading relationships with various liquidity provider counterparties is one option (e.g. increase the number of repo and securities lending trading counterparties to maximize the use of assets and secure access to cash or required collateral). Clearstream's triparty framework serves as a hub for a range of sell and buy side conterparties (multi national and regional banks to corporate treasurers and asset managers) thus serves to maximize access to required liquidity. Another solution is turn to the cleared model thus gaining access to numerous market participants, benefiting from cross product netting opportunities, while facing the CCP as sole counterparty to all trades (e.g. Eurex Clearing). Clearstream as collateral agent and market infrastructure provide services both in the cleared and uncleared spaces, helping firms connect to a wide network of trading optionality.
A single pool of collateral
Clearstream helps firms navigate towards a holistic approach to collateral management and achieve the targeted operational excellence to overcome fragmentation. This entails, for instance, offering the ability to mobilise collateral between different uncleared and cleared activities, to bridge the bilateral and triparty collateral management spaces, source collateral from different settlement locations and access CCP services. Ultimately, customers benefit from netting, collateral transformation, reuse and optimisation opportunities but also from access to a global collateral network built through collaboration and partnerships with other Central Securities Depositories, market infrastructure providers and vendors greatly increasing collateral velocity and efficiency at no additional cost to the customer.
Cross asset class capabilities
Collateral management solutions have historically tended to focus on individual asset classes with perhaps an exception for large, global banking focused systems, but the solution offered by Clearstream now allows hedge funds and other members of the buyside to benefit directly from business and technology advances originally available only to investment banks.
The Clearstream offering
The Clearstream offering is easy to deploy, integrate, configure and use, as well as being cost-effective and resource efficient.
Clearstream offer an integrated solution for all of your collateral management activity across cleared and uncleared activity, enabling you to manage your activity in an efficient and secure manner, in line with regulatory requirements. The service supports the full post-trade life cycle, from exposure valuation and contract administration to margining, collateral and dispute management, portfolio reconciliation and payment/settlement follow-up and TR reporting.
Choosing Clearstream as a partner also allows a customer to access the wider set of services provided by the Deutsche Börse group with their long pedigree in trading risk and liquidity management, collateral mobility, capital and efficient balance sheet management.
Clearstream's service is highly customisable, allowing you to subscribe to certain modules while opting out of others and giving you the flexibility to retain certain functions in-house. The key point of departure is the minimum level of standards imposed by the relevant regulations in your jurisdiction but the service allows you to go beyond these requirements to integrate additional steps for validation, risk controls, approvals and escalation.
Clearstream cover all types of financial transactions including OTC derivatives, repurchase agreements, securities lending and borrowing and other bespoke collateral agreements.
Clearstream is a leading global financial infrastructure provider delivering efficient and innovative securities services in over 110 countries. With around €14 tn in assets under custody, Clearstream operates an International Central Securities Depositories (ICSD) serving the international issuer and investor community and national CSDs in Germany and Luxembourg.
Following the implementation of Clearstream’s enhanced integrated T2S service offering, customers are able to manage their CSD and ICSD liquidity as a single pool of collateral, thereby overcoming collateral fragmentation and maximising customers’ funding and financing capacities.
In its role as collateral agent, Clearstream has long-standing in collateral management in support of cleared and uncleared activities with offerings both in the triparty and the bilateral spaces. Margin management services for CCP-cleared and non-CCP derivatives include OTC collateral management for variation margin and triparty services for the segregation and management of initial margin.