How innovation will inevitably catch up with collateral management

Like Vladimir and Estragon patiently waiting for Godot, several years after the publication of the first draft RTS that addressed the post-crisis reform in collateral management for non-cleared derivatives, many are still waiting for material changes to occur. This is despite doomsayers from far and wide predicting all manner of margin-related catastrophes in the years leading up to and following the implementation of these new rules.

While tales of impending doom have been largely overhyped, there is now evidence of material change on the horizon. Partly driven by new regulation and partly by the banks themselves as they adapt to the ‘new normal’, many now believe that there will be significant changes in the practice of managing collateral in the very near term.

A problem child is born

Much of what we know beyond any reasonable doubt relates to the sellside. Not a week goes by without a bank announcing a swathe of job cuts, a capital raising or a retreat from a certain sector or service. All this is part of a ‘business simplification’ agenda designed to deliver a leaner, meaner bank, and one that is better able to deliver double-digit return on equity (ROE) under the new regulatory regime.

A key element of this agenda is a search for increased operational efficiency. For many, this search begins with increased automation. In fact, in many respects, where a reduction in risk also forms part of business simplification, increased automation has become the holy grail.

As chief operating officers and chief technology officers turn stones looking for opportunities where they might sprinkle some of their automation ‘magic’, collateral has – for all the wrong reasons – come under the spotlight. The reason is clear as outside of intra-tier 1 trading activity, a good deal of the processes which comprise collateral management operations have for many years remained stubbornly manual and hence labour intensive. In the context of business simplification, collateral management has started to look like a problem child.

So far so normal

In the build-up to the 2008-09 global financial crisis, where collateral was concerned, banks were very much focused on the ‘optimal’ usage of their available inventory. In many institutions this ‘enterprise wide’ push for optimisation trumped the drive for operational efficiency. This is absolutely not to say that there wasn’t any focus on operational efficiency and this was not the overarching goal. What developments were made were most often limited to the activity between the very largest institutions; for example the expansion of the use of triparty collateral management, the introduction of AcadiaSoft for over-the-counter (OTC) derivative messaging and automated reconciliations.

As the sands have shifted, so have priorities. As a direct result of the demand for efficiency, it is now imperative that banks expand to the remainder of their client base the automation they have achieved when collateralising their bulge-bracket counterparts. This automation is characterised by straight-through processing (STP) of all margin related activity whether it be a simple margin call, a dispute, a substitution or any of the other peripheral processes associated with margin management. It represents the total eradication of email and phone calls which prevail today.

Interests aligned

Viewed from a treasury operation’s perspective, the banks’ demand for greater productivity has come at a very interesting time. The use of collateral amongst this constituency is undeniably growing.  Higher values of collateral are being exchanged against an increasing number of instruments. In short, it is becoming more costly and complex with a correlated increase in risk. In addition, there is also the suggestion that, as banks ‘rationalise’ their client bases (itself part of the simplification agenda), there is some consideration paid to the level of automation that exists.

The end of the beginning

As evidenced by the lack of adoption, current available market solutions simply do not pass muster. As is often the case, innovation is required to bridge the gap. Some firms within the industry are now looking to newer, more novel approaches to piece the puzzle together. The talk of utility type functions or ‘hubs’ is now far more commonplace than was previously the case. A migration towards the ‘cloud’ has already begun in earnest. Week in, week out new partnerships are forged to bring the combined strengths of two organisations to bear.

It does not seem unreasonable to imagine that all of these approaches will in some way contribute to an overall resolution. The key message here, however, is that these changes are happening now.  For the buyside especially, whether you are a treasurer, a chief operating officer or part of an operations group, it is key to understand which solutions are available and how they might impact your organisation. Further, it is important to understand that the need for change may not be driven by your needs so much, as those of your counterparts, the banks.

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