A group of global custodian banks are working together to establish a standardized format for margin statements to automate the reconciliation process between FCMs and custodians when managing collateral activity of their buy-side clients for cleared swaps. Judson Baker, Product manager at Northern Trust, is one of the key industry leaders behind this initiative, and he explains the big plans for this small working group.
Q: Can you briefly tell us about the new industry working group and why you have come together to focus on standardizing margin statements for central clearing margin activities?
A: The working group is made up of two other custodians, other than Northern Trust, and a consulting firm. Collectively, we are working to develop a standardized format for margin statements needed to report collateral activities of our clients when clearing swaps.
The margin statement will include fields, headers and descriptions in a message and is based on the data elements we agreed that we want to receive and in a format, which is desirable. The standard format is likely to be in XML format but we are also exploring alternative message formats, such as FpML. The next step is to reach out to the Futures Commission Merchant (FCM) community to see if they can comply with the suggested standard statement format.
Use of a standardized statement format will allow us (and the FCMs) to operate a more cost efficient process by saving both parties the time and resources required to reconcile data from various statement formats, which requires different data fields to be interpreted and is thus operationally intensive.
Q: Can you elaborate on main drivers behind this move to standardize margin statements now?
A: For futures, both the custodians and the brokers have developed processes and tools to better reconcile data between parties, so the investment has already been made to build up that capability to support data reconciliation and validation between broker and custodial systems. This investment in technology, which was significant, was made several years ago.
Looking ahead, margin statements will need to include new data elements to support cleared swaps with the introduction of central clearing. So, to avoid reinvesting a comparable size of development to support these new data elements, we agreed it would be more suitable to consolidate down to one file format, if possible, which will be adopted by the major custodians and the major FCMs to create a market standard.
Although there are only three custodians currently working on this margin statement standard, we aim to branch out to other custodians who could use these file formats once the common statement specifications are confirmed and approved by the FCM community.
Q: Can you explain how this margin statement process is currently completed? And what are the main operational, cost and risk benefits inherent in this process?
A: The worst-case scenario is that broker margin statements for their buy-side clients could be sent to the custodians via fax using a PDF or sent electronically via an FTP process.
Just reading, interpreting or managing files sent in different file formats, whether that is CSV, Excel, PDF or others, is operationally burdensome. We want to get to a place where we have two different file types, a CSV file format and XML for instance, which can be integrated easily into data systems and reconciled in an automated fashion.
The custodian bank community knows it will have to reconcile with FCMs. There is no doubt about that. This initiative to standardize the margin statements will reduce two things: capital spend and the operational burden.
By reducing the investment required to managing multiple file format, a firm can re-allocate this capital and spend it on other areas to bring automation, or another kind of improvements to our clients from a service perspective. On the operational front, a firm will not require as many staff and resources to support the reconciliation process by improving the automation and thus achieving greater operational efficiency.
From a client perspective, the cost savings will be passed onto our asset management client base, which is important to us so we can better support the clients as they clear swaps via central counterparty (CCP) clearing. We want our clients to clear as much as possible so we want to avoid cost being a barrier for them.
Q: For the margin statement initiative, what are the next steps? And what is the expected timeframe for this initiative?
A: The next step in this initiative is to talk with some other formal working groups to gain support because we want to progress to the next level and will require assistance from a funding, program management and governance perspective, which is necessary to ensure the initiative progresses in the right direction.
We have working specifications for the statement and we have already had conversations with a handful of FCMs to gauge their willingness to comply with us, so we are already progressing. The only concern is we just want to make sure this initiative is followed through and we start actually building up something that is tangible instead of just a great concept. The next step is to invite other custodians to get involved because we want to harmonize as much as we can among the asset servicing community.
As for the timing, we would like the standardized margin statement to be a 2012 initiative or at least to start in 2012 with production in early 2013. Also, we really need to get the standardized statement ready before mandatory clearing kicks in – that would be my view of success for the initiative. A growing number of firms are clearing ahead of the mandatory deadline but we anticipate the deadline to come into force in December 2012.
Q: What’s the next step for the working group? Are you looking to work closely with any other established industry groups to spearhead some of your own initiative and incorporate that into larger broader goals?
A: The Asset Managers Forum (AMF), which is part of SIFMA, has set up a collateral management committee to work on all things related to collateral, so there is potential overlap with that committee although their scope is much broader.
There may be sub committees that are born out of this AMF collateral committee. And if so, it would probably be logical to carve out a group of some asset managers or the custodians to talk through, flesh out the issues and try to work towards solutions. I think this is where we will see the custodians driving the conversation. We all agree that these are issues that don’t just plague one firm but the community as a whole. And for these particular issues we can come together and develop standards and then present them to the asset managers. The collaboration between both groups is crucial because if the custodians are all willing to automate and process for the benefit of their clients, the buy side will need to meet the custodians half way and make their own commitments for the greater good of the entire industry.