Today regulation continues to remain a front and centre issue, with market participants looking to adapt their business models to respond to a changing securities finance landscape. Todd Crowther, Pirum’s head of innovation, looks at industry-wide forces for change and the resources and solutions available for firms to achieve this transformation.
The market has faced a global regulatory deluge of late and businesses have had to manage the multiple, and sometimes competing, demands posed by Mifid II, Dodd-Frank, Emir and Basel III. Whilst many of these are global regimes, Asian jurisdictions have stood out as early adopters with China, India, Hong Kong, Japan and Singapore being amongst the first to implement the Basel III capital requirements. Additionally, Asian jurisdictions have more recently led the charge in terms of embracing the G20’s over-the-counter (OTC) derivative reforms reflected by the fact that there are at least seven APAC OTC derivative clearing houses currently live.
REGULATORY IMPACT: Consequences to Collateral
Due to the regulatory focus on reducing systemic risk through secured transactions and margin offset, it’s never been more important that institutions have efficient exposure and collateral management processes in place to address these sweeping market changes. There are a number of regulatory factors driving firms to review their collateral management capabilities:
The complexity of fulfilling margin requirements through collateralisation is becoming increasingly onerous. The Emir and Dodd-Frank mandates, which have extraterritorial reach outside both Europe and the US, have mandated increased centralised clearing as well as imposed uncleared OTC margin requirements for derivative transactions. This phased implementation will mean that more products as well as more participants will be increasingly caught up by the requirement to post margin and manage collateralised exposures with counterparts. The global nature of these regulations means the process of margin and exposure management should now be managed holistically across different time zones, to strict regional cut-offs, along differing eligibility rule sets and over an expanding set of margin venues as well as individual account structures.
Asian derivatives markets will likely suffer disproportionately from BCBS-IOSCO’s proposed higher mandatory margining requirements for non-cleared derivatives because many of these products are more heavily traded in Asia to hedge real, economic risks including foreign exchange (FX) options, caps and floors to swaptions and cross-currency swaps.
Supply & Demand Drivers
Increased demand and suppressed supply of collateral means that the cost of raising or transforming eligible collateral has become increasingly expensive. The mandating of centrally cleared and OTC cleared derivatives by the G20 BCBS has increased the net levels of margin required in the market. Concurrently, the FSB is mooting the introduction of mandatory haircut floors for both repo and securities lending which could again see a hike in collateral requirements. Meanwhile, quantitative easing by various central banks and the UCITS IV regimes has reduced available collateral by restricting the amount of freely tradeable inventory of high-quality liquid assets (HQLA). The response of market participants to this evolving landscape has resulted in them looking for ways to efficiently manage their margin requirements and available inventory.
Cost and capacity for collateralisation is also being tested due to Basel III and IV mandates which prescribe minimum capital and liquidity requirements for regulated firms. Liquidity Coverage Ratio (LCR) and Net Stable Funding Ratio (NSFR) directly impact the behaviour of market participants using Securities Financing Transactions (SFTs) to facilitate the collateralisation process. Due to these regulations, trading an SFT now requires more capital to be held thus increasing the cost of collateralisation by making it more expensive for market participants to raise or deploy assets for collateral purposes. As the cost of facilitating this activity has become more expensive, it has in turn has reduced overall capacity for collateralisation in the system.
The impact of compliance to these regulatory regimes has caused most institutions involved in secured finance trading to reconsider their processes and architecture. In addition to regulatory adherence, most firms are also looking to improve overall automation, efficiency and ultimately return on capital. In order to accelerate this evolution, the industry is increasingly employing external providers, as a more agile and efficient alternative to managing in-house business transformation.
FIRMS ADAPT: The Rise of Enterprise-wide Collateral Management
As firms adjust their business models, an area of development within many firms is the adoption of an ‘Enterprise Collateral Management’ (ECM) function to centralise the collateral trading, funding and margining functions.
Financial institutions are increasingly recognising the advantages of centralised collateral management. An ECM’s remit is to service multiple related collateralised products whilst optimising a firm’s use of capital as well as unifying its approach to liquidity and counterparty risk management. In terms of meaningful impact, a recent Deloitte study reported that a 1% increase in collateral efficiency could result in approximately $1.2m additional revenue per billion units of collateral for an investment bank.
However, this is not without its challenges, as a well performing ECM function is a complicated and data-intensive operation, demanding high-levels of analytics, straight-through processing capability and connectivity often for multiple product (and system) silos within a firm as well as across a multitude of external market counterparts. These complex challenges are encouraging institutions to weigh-up the options to harness effective management of collateral and they are increasingly turning to technology and automation as a means of ensuring its success.
One of the initial building blocks of ECM is an efficient process for exposure management and this operational function is often the initial focal point for many of our clients. Exposures have historically been captured in static time slices where the identification, calculation and resolution of exposures is a highly manual and often error-laden process. Process improvements can prevent human error, reduce untimely delays and add efficiencies to exposure management with demonstrable impact to a business’s overall control and profitability.
INDUSTRY TRENDS: The Rise and Rise of Tri-party Collateral Management
In recent years, we have seen the proliferation of non-cash collateral as a means of managing exposures more effectively in securities finance. Tri-party providers have become pivotal in acting as agent to help industry participants more easily facilitate their management of collateral with counterparts.
Tri-party is also being increasingly relied upon as the preferred settlement method due to the increased regulatory and operational requirements of non-cleared initial margin. With the added complexity of segregated margin accounts, requisite T+1 settlement and varied concentration limits, it is no wonder that tri-party agents have become the obvious ‘go to’ solution.
In this regard, Pirum has been working with its clients to build on our existing, real-time market connectivity in order to provide a powerful, post-trade turn-key solution to improve connectivity and efficiency of their margin and collateral management processes. Pirum connects in real-time to BNY Mellon, JPMorgan, Euroclear and Clearstream and currently calculates in excess of $1 trillion of required collateral value on a daily basis for its clients.
BACK-OFFICE BUILDING BLOCKS: Pirum’s ExposureConnect Service
Pirum’s ExposureConnect Service (ECS) fully automates the middle and back office margin management process from initial calculation of exposure, to reconciliation and agreement through to actual collateralisation. Leveraging Pirum’s proven transactional reconciliation and connectivity platform, ECS enables rapid exposure break analysis by quickly highlighting dispute root causes and helping to facilitate timely resolution.
ECS manages the entire margin management lifecycle in near real-time across all secured financing transactions. It enables both one-sided or two-sided agreement and offers an exception based, workflow tool for the effective management of exposures. From a single dashboard, the service also provides operational oversight and management for the entire post-trade process.
Built in collaboration with our clients, this solution ensures an institution has coverage across all of its collateralisation methods including any non-cash, cash pool, cash rebate and inter-company collateral exposure for securities lending and repo transactions.
ExposureConnect offers the following features:
- A centralised platform for calculating, communicating, agreeing and recording exposures with all counterparts across all collateral venues (bilateral, tri-party, central counterparty)
- Full counterparty-to-counterparty exposure agreement workflow
- A multi- product capability across equity, fixed income, financing, repo and collateral trades all in one environment
- A complete audit trail and retrospective details of exposure agreements
- Live trade and exposure updates from client systems, counterparties, tri-party agents, trading venues and central counterparties
- A management dashboard for identifying key risks and alerts to significant exposure changes
- Filters for enabling the management of individual exposure groups with current and projected exposure values visible
- A ‘Follow The Sun’ model through which global exposures can be effectively managed
- Combined with other Pirum post-trade services, exposure management becomes an exception-based model with straight-through processing capabilities.
FRONT OFFICE DECISION MAKING: Introducing Pirum’s New CollateralConnect Service
Developed in collaboration with our clients, the CollateralCollect Service (CCS) is a front-office collateral management solution which acts as a natural extension of our industry leading back- and middle-office solutions including ExposureConnect.
CCS aims to support the model of Enterprise-wide Collateral Management by providing a near real-time, centralised view across a firm’s entire exposure set including its equity, fixed income and derivatives requirements. CCS enables traders to view and act in covering these exposures across all of its external margin venues irrespective of how the product is traded. The CCS platform achieves this by providing a single dashboard of all deployed and available assets as well as a projection of forecasted exposures.
Collateral Provider’s perspective
CCS enables providers to action their collateral requirements by effecting the coverage of margin exposures, efficiently delivering collateral and ensuring best use of their collateral pool. CCS aims to enhance decision making for the efficient deployment of inventory by incorporating a firm’s specific constraints at that time of trading which includes factors such as capital position, counterparty credit limits and balance sheet usage.
Collateral Receiver’s perspective
The service independently monitors receivers’ eligibility requirements and alerts the user should a collateral allocation deviate from their preferred risk profile. CCS works seamlessly with Pirum’s Tri-party RQV and ExposureConnect Services in terms of providing a real-time view and workflow tool to monitor, quickly resolve and manage exposure.
CollateralConnect offers the following features:
- Real-time exposure view of trades, collateral requirements and collateral security allocations for cash, non-cash bilateral and tri-parties
- Historic trending and forecast analysis of pending exposures as well as collateralisation
- Digitised collateral schedules stored for query, management and/or analysis
- Collateral management tools to identify eligibility requirements and drive efficient collateralisation using available and accessible inventory
- Collateral financing management information designed to control costs and enhance profitability
Pirum’s Collateral Management suite of products including CCS & ECS benefits our users by delivering:
- Reduced operational risk through better end-to-end management of key transactional and exposure lifecycle events
- Improved control and transparency ensuring reduced credit and operational risk as well as enhanced supervision and audit trail
- More timely and accurate resolution of exposures which help to better comply with mandated regulatory timeframes and optimise resource efficiencies
- Less manual processing, reduced key staff dependencies and improved business scalability
- Improved post-trade analytics to enable better management of collateralisation impacts to financial resources, prudential compliance and/or risk-return profile
- Better pre-trade decision support to identify collateral inefficiencies and aid in determining how best to raise, distribute or utilise existing inventory
- Easy and flexible integration with minimal in-house build
A MODEL FINTECH PARTNER: Pirum’s Commitment to Client Innovation
Pirum has a proven track record of working with our clients to deliver cutting edge, easily implementable solutions to solve complex problems. Positioned at the heart of the market, our central connectivity and automation hub brings together disparate data sources and creates a network of connectivity across trading counterparties and industry-wide infrastructure providers.
Pirum has therefore been in the fortunate position to collaborate with our clients to build an effective and efficient solution to the collateral problem statement.
Regardless of whether firms have decided to centralise the collateral management function or continue to handle it departmentally, the visibility provided of all sources and uses of collateral and eligibility of assets is a significant step towards building a more efficient collateral management function.
By understanding all the opportunities, risks and costs, managers will make more efficient collateral allocations and traders will make better informed execution decisions, leading the industry to better address the impacts of regulation and the use the finite resources available.
For more information or to see CollateralConnect in practice, please contact us at connect@Pirum.com or via www.pirum.com.