The ideal solution
21 Jul 2021
Collateral management has evolved over the years gone by since the financial crisis, but with the final phases of UMR coming up, experts discuss the ideal solution in this space
Image: zffoto/stock.adobe.com
For hundreds of years collateral has been used to provide a safety net for the possibility of a payment default by the opposing party in a trade. In the 1980s, Bankers Trust and Salomon Brothers introduced collateral management as they began taking collateral against credit exposure.
Fast forward to today, and collateral management now makes up an important element of front-to-back solutions. Now, with the final phases of the uncleared margin rules (UMR) fast approaching, having a robust, efficient and automated collateral management solution is crucial.
Experts believe that collateral management is going to be part of many functions that a bank or asset manager carries out. This includes being part of the trading decision, risk management, simulations — such as stress scenarios in case the market moves — and part of counterparty credit risk.
Hervé de Laforcade, global head of marketing, Calypso, comments: “10 years ago, financial institutions would typically select and implement a collateral management system as if they were choosing a trading system, a portfolio management system or a treasury management system, and then integrate that new platform with the rest of their ecosystem. Today the collateral management needs to be fully part of each of those ‘packages’ and become central to any front-to-back platform.”
Collateral management transformation, therefore, remains on the top of the priority list for many financial institutions.
Such transformation requires firms to assess their end-to-end operating model across technology, processes and data.
Technology has a crucial role to play when it comes to collateral management, particularly when dealing with major regulations such as UMR.
Wassel Dammak, director of collateral management at Vermeg, says: “Technology is the main enabler because it is the catalyser for innovation.”
“Financial firms can rely on third-party vendors that invest heavily in their solutions to onboard new technologies in a timely manner, cope with regulatory updates and implement market practices and standards.”
Dammak suggests technology is also a differentiator because it can reduce collateral costs, achieve better profitability and help to offer additional services to clients and counterparts.
With this in mind, technology is therefore going to be crucial to market participants in navigating challenges around collateral management.
Challenges
Vermeg’s Dammak identifies ‘doing more with less’ as a challenge, which relates to achieving sustainable efficiency.
Financial firms are constantly looking to simplify their systems landscape and to consolidate their collateral management across asset classes and business lines.
Dammak says this can be split up into three sub challenges:
Technical efficiency through the reduction of the IT infrastructure cost by leveraging cloud/ Software as a Service (SaaS) deployments and services, and potentially benefit from Open Source database management systems like PostgreSQL
Operational efficiency by using a unique system to automate margin calls workflow, communications and settlements with potential cross-margining capabilities whenever possible
Efficiency of the inventory usage by centralising an overall enterprise real-time inventory with post trade optimisation (cheapest to deliver) capabilities
Data and digital workflow represent further challenges in this space, and experts suggest the ability for service providers to stand out with digital innovation will be crucial in the post-COVID-19 era. Market participants are looking to access relevant data in the most flexible but automated way possible.
However, some firms have old legacy systems, and some have disparate systems where data is held in multiple places. Additionally, there is still a set of organisations that are using spreadsheets or spreadsheet-like tools to manage their daily collateral process.
Darren Crowther, general manager, securities finance and collateral management, Broadridge, suggests it is about bringing data together to a common data repository that allows them to report, which has been a challenge for some.
Another area that keeps market participants awake at night is collateral mobility and optimisation.
Tilman Fechter, head of banking, funding and financing at Clearstream, comments: “With interest rates remaining at industry-wide lows, firms continue to look at ways to create more profitable relationships using funding and financing with clients and continue to assess different opportunities to reduce balance sheet usage.”
“All market firms remain extremely cost conscious and we see increasing pressure on financial market infrastructure to offer process harmonisation in a recurring drive to reduce bottom line for clients.”
To achieve greater efficiency within collateral management, some market participants are automating their processes and are replacing legacy systems.
Since the financial crisis in 2008, automating collateral operations has been a core focus. Financial institutions have invested in more robust solutions around automation of the margin workflow. Experts believe those investments have largely contributed to the global success of financial institutions’ collateral departments in coping with the spike of margin calls’ volumes during times of market volatility and liquidity stress caused by the COVID-19 crisis.
Keeping up with regulatory changes is key in the collateral management space, and participants have to interpret and implement regulatory change in a manner that is both time and resource-efficient.
Simon Millington, CloudMargin’s head of business development, comments: “UMR has made having a robust, efficient and comprehensive collateral management programme more important than ever.”
According to Millington, the broad regulatory changes under UMR have not only created an increased need for collateral, with increased lending and borrowing, but are also driving wider adoption of tri-party agents in the settlement process. At the same time, firms need broader connectivity to other services across the collateral lifecycle, including market utilities and custodians, Millington explains.
UMR’s new regulatory initial margin requirement mandated that every market participant had to modify their existing collateral management systems and processes.
Acadia’s Mark Demo, head of community development, notes that at the same time, market participants joined together to create a central initial margin calculation and reconciliation market infrastructure service hosted by Acadia that is fundamentally changing how initial margin is managed across the industry.
Acadia and CloudMargin have collaborated on a solution that enables phase 5 and 6 firms to send a simple trade file and choose to calculate via SIMM or Grid.
Acadia’s Collateral Manager, powered by CloudMargin, compares the initial margin amounts against the counterparty’s calculated amounts and sets thresholds allowing the firms to validate their calculations and monitor their exposures.
The ideal solution
There are many solutions out there designed to help market participants combat some of the above challenges, such as data management, systems harmonisation, and regulation. But what does the ideal solution look like?
A typical collateral user could be a hedge fund, a small regional bank, an asset manager or a larger bank. They want a solution that is simple, accurate and available at any time.
Sophie Marnhier-Foy, head of product marketing at Calypso Technology, says: “Behind the scenes, new calculations, sometimes complex, are required but the process has to look as simple as a spreadsheet for them.”
Marnhier-Foy continues: “But it is not just a question of managing the collateral. It is really about accessing that collateral information whether you are a risk manager, a trader, or a post trade operation manager. Indeed, they all need to optimise collateral at their level, quite systematically, and for a few different reasons. For example, volatile market movements will require more anticipation of upcoming margin calls.”
Broadridge’s Crowther believes the ideal solution would be a stable platform that is available 24/7 and typically hosted on a private or public cloud to give the user resilience. He says: “As a collateral manager, you do not want to have to worry about the technology or have the additional burdens of managing technology; that is not a collateral manager’s function as they are not specialists in doing that. Therefore, you want a provider to be able to deliver those services for you.”
Depending on the type of organisation, Crowther suggests you may also look for a collateral module that sits side by side with a securities finance platform to centralise inventory and harmonisation across products which allows for a cross product harmonisation capability. Additionally, the user would be looking for front-to-back functionality or a platform that can easily integrate into other platforms.
However, Demo muses: “The answer is that it does not look like anything. When collateral management software is designed correctly it becomes invisible.”
“It takes the time-consuming manual tasks that were previously stumbling blocks to an efficient process, automates them and presents management with data and straight-through processing exceptions that were previously not visible and or available to make faster and more informed decisions,” Demo adds.
The evolution of collateral management
The future of collateral management is likely to involve greater automation, new ways to settle collateral, and a push towards the consolidation of collateral management.
Clearstream’s Fletcher states technology remains a key enabler to collateral management now and will continue to be for the future. Fletcher affirms: “One interesting trend that we continue to track is the opportunity to mobilise and issue digital or tokenised assets.”
“Historical settlement and collateral management processes have always been based on the capability of firms and market infrastructure to move assets from A to B as swiftly and efficiently as possible.”
According to Fletcher, the opportunity to use digital assets has turned the world on its head, and for collateral markets, it allows collateral baskets and any underlying assets to be immobilised centrally but freely transferable.
From a cost perspective, Fletcher highlights this is incredibly disruptive and something that banks and financial institutions will be paying exceptionally close attention to for years to come.
Meanwhile, Marnhier-Foy suggests that the collateral function is evolving towards being a part of every step of a trade lifecycle and is critical for many actors in a bank. She says: “The lines between bank functions will be blurred when it comes to collateral. A good example is the risk and collateral integration, where collateral inputs are required to calculate accurate collateralised risk exposures.”
“When you look at what it means from a system perspective, the upcoming industry trends will be quite interesting. Will firms look for specialised collateral services or integrated front-to-back platforms with modular adoption?”
Marnhier-Foy adds: “Based on what clients are telling us, the latter seems to be the preferred choice where collateral becomes available at every step of the value chain.”
Fast forward to today, and collateral management now makes up an important element of front-to-back solutions. Now, with the final phases of the uncleared margin rules (UMR) fast approaching, having a robust, efficient and automated collateral management solution is crucial.
Experts believe that collateral management is going to be part of many functions that a bank or asset manager carries out. This includes being part of the trading decision, risk management, simulations — such as stress scenarios in case the market moves — and part of counterparty credit risk.
Hervé de Laforcade, global head of marketing, Calypso, comments: “10 years ago, financial institutions would typically select and implement a collateral management system as if they were choosing a trading system, a portfolio management system or a treasury management system, and then integrate that new platform with the rest of their ecosystem. Today the collateral management needs to be fully part of each of those ‘packages’ and become central to any front-to-back platform.”
Collateral management transformation, therefore, remains on the top of the priority list for many financial institutions.
Such transformation requires firms to assess their end-to-end operating model across technology, processes and data.
Technology has a crucial role to play when it comes to collateral management, particularly when dealing with major regulations such as UMR.
Wassel Dammak, director of collateral management at Vermeg, says: “Technology is the main enabler because it is the catalyser for innovation.”
“Financial firms can rely on third-party vendors that invest heavily in their solutions to onboard new technologies in a timely manner, cope with regulatory updates and implement market practices and standards.”
Dammak suggests technology is also a differentiator because it can reduce collateral costs, achieve better profitability and help to offer additional services to clients and counterparts.
With this in mind, technology is therefore going to be crucial to market participants in navigating challenges around collateral management.
Challenges
Vermeg’s Dammak identifies ‘doing more with less’ as a challenge, which relates to achieving sustainable efficiency.
Financial firms are constantly looking to simplify their systems landscape and to consolidate their collateral management across asset classes and business lines.
Dammak says this can be split up into three sub challenges:
Technical efficiency through the reduction of the IT infrastructure cost by leveraging cloud/ Software as a Service (SaaS) deployments and services, and potentially benefit from Open Source database management systems like PostgreSQL
Operational efficiency by using a unique system to automate margin calls workflow, communications and settlements with potential cross-margining capabilities whenever possible
Efficiency of the inventory usage by centralising an overall enterprise real-time inventory with post trade optimisation (cheapest to deliver) capabilities
Data and digital workflow represent further challenges in this space, and experts suggest the ability for service providers to stand out with digital innovation will be crucial in the post-COVID-19 era. Market participants are looking to access relevant data in the most flexible but automated way possible.
However, some firms have old legacy systems, and some have disparate systems where data is held in multiple places. Additionally, there is still a set of organisations that are using spreadsheets or spreadsheet-like tools to manage their daily collateral process.
Darren Crowther, general manager, securities finance and collateral management, Broadridge, suggests it is about bringing data together to a common data repository that allows them to report, which has been a challenge for some.
Another area that keeps market participants awake at night is collateral mobility and optimisation.
Tilman Fechter, head of banking, funding and financing at Clearstream, comments: “With interest rates remaining at industry-wide lows, firms continue to look at ways to create more profitable relationships using funding and financing with clients and continue to assess different opportunities to reduce balance sheet usage.”
“All market firms remain extremely cost conscious and we see increasing pressure on financial market infrastructure to offer process harmonisation in a recurring drive to reduce bottom line for clients.”
To achieve greater efficiency within collateral management, some market participants are automating their processes and are replacing legacy systems.
Since the financial crisis in 2008, automating collateral operations has been a core focus. Financial institutions have invested in more robust solutions around automation of the margin workflow. Experts believe those investments have largely contributed to the global success of financial institutions’ collateral departments in coping with the spike of margin calls’ volumes during times of market volatility and liquidity stress caused by the COVID-19 crisis.
Keeping up with regulatory changes is key in the collateral management space, and participants have to interpret and implement regulatory change in a manner that is both time and resource-efficient.
Simon Millington, CloudMargin’s head of business development, comments: “UMR has made having a robust, efficient and comprehensive collateral management programme more important than ever.”
According to Millington, the broad regulatory changes under UMR have not only created an increased need for collateral, with increased lending and borrowing, but are also driving wider adoption of tri-party agents in the settlement process. At the same time, firms need broader connectivity to other services across the collateral lifecycle, including market utilities and custodians, Millington explains.
UMR’s new regulatory initial margin requirement mandated that every market participant had to modify their existing collateral management systems and processes.
Acadia’s Mark Demo, head of community development, notes that at the same time, market participants joined together to create a central initial margin calculation and reconciliation market infrastructure service hosted by Acadia that is fundamentally changing how initial margin is managed across the industry.
Acadia and CloudMargin have collaborated on a solution that enables phase 5 and 6 firms to send a simple trade file and choose to calculate via SIMM or Grid.
Acadia’s Collateral Manager, powered by CloudMargin, compares the initial margin amounts against the counterparty’s calculated amounts and sets thresholds allowing the firms to validate their calculations and monitor their exposures.
The ideal solution
There are many solutions out there designed to help market participants combat some of the above challenges, such as data management, systems harmonisation, and regulation. But what does the ideal solution look like?
A typical collateral user could be a hedge fund, a small regional bank, an asset manager or a larger bank. They want a solution that is simple, accurate and available at any time.
Sophie Marnhier-Foy, head of product marketing at Calypso Technology, says: “Behind the scenes, new calculations, sometimes complex, are required but the process has to look as simple as a spreadsheet for them.”
Marnhier-Foy continues: “But it is not just a question of managing the collateral. It is really about accessing that collateral information whether you are a risk manager, a trader, or a post trade operation manager. Indeed, they all need to optimise collateral at their level, quite systematically, and for a few different reasons. For example, volatile market movements will require more anticipation of upcoming margin calls.”
Broadridge’s Crowther believes the ideal solution would be a stable platform that is available 24/7 and typically hosted on a private or public cloud to give the user resilience. He says: “As a collateral manager, you do not want to have to worry about the technology or have the additional burdens of managing technology; that is not a collateral manager’s function as they are not specialists in doing that. Therefore, you want a provider to be able to deliver those services for you.”
Depending on the type of organisation, Crowther suggests you may also look for a collateral module that sits side by side with a securities finance platform to centralise inventory and harmonisation across products which allows for a cross product harmonisation capability. Additionally, the user would be looking for front-to-back functionality or a platform that can easily integrate into other platforms.
However, Demo muses: “The answer is that it does not look like anything. When collateral management software is designed correctly it becomes invisible.”
“It takes the time-consuming manual tasks that were previously stumbling blocks to an efficient process, automates them and presents management with data and straight-through processing exceptions that were previously not visible and or available to make faster and more informed decisions,” Demo adds.
The evolution of collateral management
The future of collateral management is likely to involve greater automation, new ways to settle collateral, and a push towards the consolidation of collateral management.
Clearstream’s Fletcher states technology remains a key enabler to collateral management now and will continue to be for the future. Fletcher affirms: “One interesting trend that we continue to track is the opportunity to mobilise and issue digital or tokenised assets.”
“Historical settlement and collateral management processes have always been based on the capability of firms and market infrastructure to move assets from A to B as swiftly and efficiently as possible.”
According to Fletcher, the opportunity to use digital assets has turned the world on its head, and for collateral markets, it allows collateral baskets and any underlying assets to be immobilised centrally but freely transferable.
From a cost perspective, Fletcher highlights this is incredibly disruptive and something that banks and financial institutions will be paying exceptionally close attention to for years to come.
Meanwhile, Marnhier-Foy suggests that the collateral function is evolving towards being a part of every step of a trade lifecycle and is critical for many actors in a bank. She says: “The lines between bank functions will be blurred when it comes to collateral. A good example is the risk and collateral integration, where collateral inputs are required to calculate accurate collateralised risk exposures.”
“When you look at what it means from a system perspective, the upcoming industry trends will be quite interesting. Will firms look for specialised collateral services or integrated front-to-back platforms with modular adoption?”
Marnhier-Foy adds: “Based on what clients are telling us, the latter seems to be the preferred choice where collateral becomes available at every step of the value chain.”
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