Algorithmics today announced the findings of a new survey of collateral management practices and challenges in buy-side institutions around the world, which found weakness in some collateral processes and concern among firms about the impact of central counterparty clearing on the buy side.
The survey, ‘Collateral Management for the Buy Side: Emerging Challenges and Best Practices in a Changing Regulatory Environment’ was conducted by Algorithmics, the leading provider of risk solutions, and Chromozome Consulting, the collateral management and derivatives consultancy, and features responses from 80 buy-side institutions around the world, including asset managers, hedge funds, pension funds and custodians.
Dr Andrew Aziz, executive vice president of Risk Solutions at Algorithmics, commented: “We have seen collateral management practices in buy-side firms evolve rapidly in the years since the financial crisis. Add to that the new requirements of the changing regulatory environment and it becomes clear why the buy side continues to experience increased growth in requirements around the collateral management process.”
Neil Murphy, director, Collateral Management, Algorithmics, added: “The findings of this survey confirm that the buy side has basic collateral management processes in place and sophisticated ambitions in areas such as collateral optimization. However, the low incidence of daily margining reveals the absence of some basic risk processes that will become increasingly important in the new world of central counterparties. Our respondents are already realizing that central clearing will not be a collateral ‘cure-all’ but will add to costs and collateral process requirements. The buy side will need to address any gaps in their collateral process now if they are to contain costs and meet this regulatory challenge.”
Key survey findings were in five areas:
• Margining – too infrequent, with 54% of respondents making weekly margin calls only
• Central counterparty clearing (CCP) – impact is still unclear but will increase costs and efforts
• Collateral optimization – 25% of respondents were interested
• Significant growth in collateral requirements regardless of CCP impact
• Eligible collateral – 55% want to use equities as eligible collateral.
1. Weak process – weekly margining heightens risk exposure
54% of respondents are making weekly rather than daily margin calls – and this is despite 84% using vendor or outsourced collateral management systems. Weekly margining exposes firms to potentially increased levels of risk, as daily changes in exposure remain uncollateralized. Weekly margining will also not meet the need for more frequent margining that central clearing will require.
2. Views on central counterparty clearing (CCP)
Institutions await full clarity on how central clearing will work in practice for the buy side but it is clear that CCP clearing will put further pressure on organizations’ day-to-day collateral processes as they need to manage more collateral contracts, with increased collateral funding needs, and with more frequent margin calls. Asked how CCP would impact bilateral collateral activity, 56% of respondents expected to need more collateral and 25% expected to see more counterparties collateralized.
3. Appetite for collateral optimization
25% of respondents were interested in optimizing collateral. At a time when the costs of collateral funding may increase, this comes as no surprise: optimizing collateral offers a way of minimizing collateral cost through efficient re-use of collateral balances. For the same reasons, 22% cited a need to measure concentration limits on collateral positions as a key priority.
4. Growth in collateral requirements
Several factors, including increased agreement volumes, larger portfolios, and greater use of initial margin, have contributed to the growth in collateral requirements. These were confirmed by the survey respondents, of whom 75% had between 100 and 500 CSA pairs, 75% had portfolios in excess of 500 live OTC positions and 72% use initial margin with 50% or more counterparties. In addition, 43% intend to validate the margin calculated by a clearer when they clear through CCP.
5. Interest in expanding types of eligible collateral
Survey respondents would like to use assets that they already have in their portfolios as alternatives to current eligible collateral asset types (such as cash, government or corporate bonds). 55% of respondents would like to use equities and 32% share of funds. However, central clearing houses are likely to require cash and high quality bonds.
Dr Andrew Aziz concluded: “This is an interesting evolutionary time for buy-side collateral professionals. For the first time, they are being held to the same operational and risk standards as their sell-side professional counterparts due to regulatory influences. Market changes may require buy-side firms to seek increasingly sophisticated services from their sell-side counterparties and third party service providers. From this snapshot of the buy side, it appears that some are better positioned than others to react to these changes, while others still need to focus on strengthening their fundamental processes.”
