The potential counterparty credit exposure on derivatives and other hedging instruments used by corporations before the great crash of 2008 has caused many large multinationals to evaluate their credit support for derivative transactions and, more specifically, the frequency of collateral exchanges. Toyota Financial Services (TFS) was no different and with an appetite for decreased counterparty credit risk exposure, increased transparency demands and the looming Dodd-Frank regulation, there was a clear need for a new operational procedure and technology system.
Thanks to a strategic initiative that involved Toyota’s own Kaizen Methodologies, and technology supported from SWIFT, Wall Street Systems (WSS) and Bloomberg Valuation Services (BVAL), TFS has become the first corporate treasury to perform daily collateral exchanges with zero credit thresholds and same-day settlement. TFS has also reduced a previous unsecured exposure from US$1bn to near zero, providing significant financial and on-going oversight benefits to the company, while also reducing operational resource requirements to support the process. This project case study, which won the Treasury Technology category at the gtnews Awards for Global Corporate Treasury 2012, is shared here to provide an overview of the new daily collateral exchange procedure in place at the firm and the technologies employed.
The first wheel came off when the 2008 financial crisis hit. Decreases in credit ratings of key financial institutions left everyone wondering if their trades had been properly collateralised. This was especially true for TFS, which had over a US$100bn in derivatives with 23 swap counterparties at the time. Fortunately, TFS had executed bilateral International Swaps and Derivatives Association (ISDA) Credit Support Annex (CSA) agreements, and monthly collateral (cash) exchanges somewhat mitigated this risk. However, due to credit limits in the agreements, TFS still had a US$1bn unsecured credit exposure and exposure to intra-month credit risks.
Then all the wheels came off. Toyota’s recall crisis, Japan’s tsunami disaster, downgrades in Toyota’s credit ratings, market volatility due to the eurozone crisis and finally, the pending Dodd-Frank regulation in the US proposing sweeping collateral management changes – all these things meant that something had to be done.
With the possibility of more frequent collateral postings, the use of a centralised exchange, and more stringent transparency requirements under Dodd-Frank, the velocity of change was at an impasse with our current collateral exchange process. Not only was our process very manual (see Figure 1), it was taking nine hours to complete and involved eight associates from four functional groups. It was not scalable, transparent or adaptable to the changing derivatives landscape.
Something had to change – and technology was the answer. TFS set out to not only develop a best-in-class new process, but to transform the process to a daily collateral exchange via automation and the effective integration of technology. Through a strategic technology initiative that would involve treasury technology partners at WSS, SWIFT and BVAL and Toyota’s own Kaizen Methodologies, the following project objectives were established:
- Deploy a technology solution that would enable TFS to perform daily bilateral collateral exchanges in a more efficient manner, requiring fewer resources and completed within two hours (previously nine hours).
- Produce internal daily valuations, replacing the dependency on counterparty as the valuation source.
- Comprehensive management and position reporting to increase transparency.
- Adaptability and scalability of the implemented technology to meet the changing regulatory landscape.
- Be more green; with a paperless process with controls and auditing for Sarbanes-Oxley (SOX) compliance.
Achieving these objectives would allow TFS to be the first corporate treasury to perform daily collateral exchanges with zero thresholds and same-day settlement. It would cut the firm’s unsecured exposure from US$1bn to near zero and provide other long-term financial benefits.
Planning and Timeframe
The technology transformation project was properly planned from the start. After management approval, a cross functional project team (see Figure 2) was formed to ensure strong alignment of objectives. A detailed project plan was completed with a start date of 1 April 2011 and an expected completion date of 31 March 2012.
Figure 2: Cross Functional/Departmental Team
As with all internal initiatives, Toyota’s foundational philosophy of improvement (Kaizen), including ‘just-in-time’ concepts, were leveraged to ensure successful project completion. This philosophy embodies two key founding principles:
- Continuous improvement.
- Respect for people.
These two key principles have guided Toyota as a Global company, since the late 1940’s and are part of our culture known as the ‘Toyota Way’ (see Figure 3).
Just-in-time concepts were leveraged as well, when working on this project. The ‘before picture’ was one of stagnant flow, with hidden waste such as batch processing and multiple rework loops. The ‘after picture’ reflects a just-in-time model, where we have independent, continuous flow, by bank, on a daily basis. Visual Cues are now present providing real time indicators for associates to process work, all with reduced cycle times and less waste, being the outcome.
Figure 3: ‘Toyota Way’ Methodology
Through utilisation of the Kaizen Methodologies, the following were discovered as opportunities from the previous existing monthly process:
- Operational processing was occurring as a batch process. For example, treasury risk would finish all of the counterparties risk analysis before handing it over to treasury operations for margin call or collateral confirmations.
- Due to the reliance on the counterparty as the valuation source, significant time was spent verifying trade population and valuation reasonability.
- Various Excel spread sheets were being utilised by the four functional groups as the source of record. This led to potential for human error and calculation mistakes.
Various components of the TFS technology solution helped achieve the project objectives. The major elements of it are outlined here:
TFS developed a web-based Microsoft.NET solution (termed RAPID) to encompass the entire collateral exchange process (calculation, confirmation and settlement). This enabled treasury to:
- Automate workflows that previously were done manually through Excel spread sheets.
- Enable just-in-time collateral exchange processing through separate workflows for operations and risk, along with visual cues for workflow states and dispute resolution (see Figure 4).
- Full dispute resolution with counterparty valuation analysis.
- Respond to timing requirements for daily collateral exchange (see Figure 5).
- Generate margin calls and valuation statements electronically.
- Perform pre-work to reduce processing time.
- Eliminate paper printing and provide reporting and controls.
Figure 4: RAPID.Net Application Developed with Just-in-time Processing and Dispute Resolution
Through the partnership with our technology vendor partners at WSS, BVAL and SWIFT, TFS was able to develop various integration interfaces (see Figure 6) that allowed for collateral exchange straight-through-processing (STP):
- Upload of the trade population and counterparty information from WSS on a daily basis into RAPID.
- Upload of valuation marks on a daily basis from WSS and BVAL into RAPID.
- Upload of counterparty valuation marks for analysis and dispute resolution.
- Forecasts to our funding desk to raise funds for collateral exchanges.
- Execution of payments/receipts from RAPID to SWIFT.
Figure 6: Integration Points in Overall Solution Architecture
Programming and user interfaces were simplified to allow for changes in active counterparties, calculation methodologies, communication methods and settlement. This enables TFS to meet any future changes due to volatile market conditions or any future regulatory actions.
- All static data (such as active counterparties, settlement information, dispute thresholds, etc) are maintained in our core treasury management system (TMS), supplied by WSS. No static data is stored in the .net application, thereby reducing any development changes whenever a new counterparty is added.
- Modular development of application to allow for changes to collateral exchange communications (clearing exchanges, use of SWIFT, etc).
Due to the daily nature of the collateral exchange process, systems and integration points had fail-back points in the event of downtime. This introduced resiliency and aided business continuity planning (BCP). A thorough failure mode analysis was performed to ensure availability and the following was implemented:
- A separate disaster-recovery environment at the file, application and database levels.
- Service level agreements (SLAs).
- Monitoring tools.
- Capability to rely on alternate valuation source.
- Dedicated support team monitoring all pre-work to ensure operational readiness.
Numerous challenges and issues had to be considered before TFS could go live with its new daily collateral exchange process and supporting technology infrastructure, such as:
- Off-the shelf, outsource, or in-house development? All three options were evaluated, but given our diverse derivatives portfolio, internal valuation capability and the cost/short timeframe, developing an in-house technology solution was the ideal decision and the route chosen (total cost US$100,000).
- East Coast/West Coast time difference: TFS is a US West Coast-based corporation and all of our derivative counterparties are located in the East Coast time zone in America. Margin calls needed to be executed by 7am pacific standard time (PST) and all processing, including dispute resolution, needed to be complete by 9am PST. This essentially left TFS with a two hour processing window, which meant that performing pre-work provided significant lift (see Figure 7).
- Non-standardisation among banks regarding the daily exchange process: Daily processing with same-day settlements and zero thresholds was a non-standard process with banks. Frequent conversations with all 23 banks TFS used occurred in order to have the process conform to the internal requirements. Due to the large number of swap counterparties, movement confirmations and settlements were all standardised to help increase the efficiency of system design and programming. This reduced implementation cost and increased return on investment (ROI).
- Project communication and execution: The Kaizen methodology was well suited for this and provided the framework and tools for weekly meetings, shared responsibility and quick execution.
Figure 7: Pre-work Performed Before Operations Starts
The benefits that have accrued from the now live TFS daily collateral exchange process and supporting technology infrastructure have been considerable and, in some cases, have gone beyond the original scope of the project, delivering:
- Reduction in costs of new derivatives execution (US$20m savings expected annually).
- Reduction of unsecured credit exposure from US$1bn to near zero.
- Daily validation of internally generated valuation marks (previously monthly).
- Greater associate engagement, communication and alignment within the entire department.
- First corporate treasury to achieve daily collateral exchange with zero credit thresholds and same day settlement.
As a result of detailed planning, rigorous testing and Kaizen Methodologies, TFS was able to successfully complete the project on 15 Oct 2011, five months ahead of schedule.
In terms of the technology solution, and on a total spend of US$100,000, TFS was able to achieve a quicker deployment time with 100% system availability and the flexibility to adapt to any future regulatory changes.
There were also considerable process efficiency benefits, as listed below:
|Total Processing Time||9 hrs||1 hr||8 hrs, 2K hours annually|
|# of Associates involved||8||3||5 not required|
|Paper Savings||750 pgs/day||Paperless||24 trees annually|
|Processing Max. # of Banks||23||40||17 additional capacity|
The project has also been a game changer in terms of effectively managing counterparty credit risk exposure within the company and the benefits are still being felt today and will be there long into the future.
• This case study is based upon an entry into the gtnews Awards for Global Corporate Treasury 2012, sponsored by Bank of America Merrill Lynch (BofA Merrill). The winners of this year’s annual awards, now in its third staging, were only revealed at a gala dinner on 24 May at the Sofitel Grand Hotel in Amsterdam, the Netherlands, after the opening of the two-day gtnews Forum for Global Corporate Treasuryconference. This winning Toyota entry is shared here from the Treasury Technology Implementation of the Year category as a best practice guideline and commentary on derivatives and technology. To see a full report on all the Awards winners and the gala dinner on 24 May please click here.
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