Your post-trade diet for your collateral workout

Ted Allen, vicepresident, collateral management, at SunGard Financial Systems

Like many a desk-bound, middle-aged professional, I work offmy stress through triathlons. One important thing I have learned about trainingand racing, is that to maximise your performance you need the right diet tocomplement your hard work. But what is more important – the pre or post workoutmeal? In collateral optimisation many professionals are faced with the samequestion. While the benefits of pre-tradeoptimisation are intuitive, a recent study by SunGard and Sapient Global Markets has demonstrated the proven cost reductions from post-trade collateral optimisationcan be impressive too.

Our study found that an improved performance of between 3 to10 basis points can be expected on a typical bank portfolio of collateralrequirements and inventory, after implementing a collateral optimisationprogramme. Post-trade optimisation results vary according to agreement quality,inventory structure and internal funding costs. A recent proof of value at alarge European bank demonstrated improved performance of 7.5 basis points. Previously,we have seen opinion and theory which may be sound, but results from a reallife study using a major bank’s inventory have not been publicised before. Suchsignificant potential savings will be of interest to treasurers and thosecharged with delivering a collateral optimisation programme.

Collateral requirements impact every part of the tradelifecycle and therefore differing optimisation approaches should be deployed ateach stage of the cycle. The final set of levers is applied after the trade ismade with the key aim of optimising the allocation of collateral assets. 

Collateral inventory optimisation allows the firm to postthe “cheapest-to-deliver” collateral after considering funding costs andopportunity costs. Collateral optimisation algorithms identify within a singleprocess the collateral that should be posted across a global set ofrequirements and the collateral that should be kept back.

The benefits of the more advanced collateral optimisationtechniques can go beyond minimising costs of collateral usage. The liquiditypotential of the available remaining inventory can be maximised as well. Thisis increasingly important because the Liquidity Coverage Ratio (LCR) and theNet Stable Funding Ratio (NSFR) introduced by the Basel III regulatorsrepresent binding constraints on short-term and medium- to long-term liquiditystrategies. The ratios force banks to set aside a larger amount of liquidassets or to curtail businesses that consume liquidity. Collateral optimisationon the other hand, can be used to mobilise liquidity and thus allow firms toconduct more business. Until recently, liquidity and balance sheet managementhave not really been considered as a component of the cheapest-to-deliverparadigm but this will change.

The key is collateral optimisation mobilises liquidity andthus, allows firms to conduct more business. It can offer significant savings,depending on a firm’s portfolio of posted collateral, constellation of counterparties,implemented processes and specific funding spreads. Optimisation techniquesprovide full cost transparency and can help financial institutions toaccurately price derivatives through collateral transfer pricing. 

Pre-trade and post-trade optimisation techniques arecomplementary rather than competing strategies. Optimising a deal on apre-trade basis through choosing the right product, counterparty and clearingvenue works hand in hand with post-trade optimal collateral allocation. Indeed,implementing a range of optimisation techniques offers various synergies anddelivers a more holistic approach with enhanced results. With this in mind, you might consider a snackbefore and after doing your workout.