Daniel McNavich, vice president, Apex Collateral, SunGard explains how the buy side can embrace some of the opportunities of using collateral to help drive added revenue and increased efficiencies including inventory management, collateral trading and optimization.
It goes without saying that global regulations have brought about increased challenges and costs associated with the use of collateral. The ability to pool collateral assets and prioritize asset utilization is an integral part of a firm’s success today and into the future, as regulators are changing the game when it comes to capital requirements. With regulations driving change, the industry is experiencing increased initial margin (IM) requirements, mandatory clearing of over-the counter (OTC) derivatives, and increased segregation of collateral assets, creating an expensive and fragmented new model.
Buy-side firms across the industry are being forced to reconsider how they use collateral and are determining how they will meet the demand for increased levels of high-quality collateral while navigating the liquidity concerns they now face. While some buy-side firms that use derivatives as a daily business activity understand the value of using collateral efficiently, many others that use derivatives on either a smaller scale or that plan on using derivatives at some point into the future have not yet fully embraced the opportunities of using collateral to help drive added revenue and increased efficiencies.
Buy-side firms can trade assets, optimize collateral, and seek collateral transformation opportunities while continuing to build out operational efficiencies using disciplined and lean collateral operations technology. Buy-side firms that are traditionally rich in high-quality assets such as U.S. Treasuries and high-quality sovereign debt may be lenders of these assets in exchange for cash or riskier, less-liquid assets. Other buy-side firms that are limited in holdings of U.S. treasuries or high-quality sovereign debt may need to utilize collateral transformation as an alternative to posting cash to meet increased IM requirements.
While the demand for high-quality, highly liquid assets are growing across the board, so is the need for a pooled or global view of the unencumbered assets. This, coupled with the warning of a collateral shortfall, should now be a top priority to ensure a firm’s ability to meet collateral requirements re-using the most cost effective assets.
To prepare for the new environment of collateral management, the buy side has much to consider, including:
· Lean Collateral Operations: A buy-side firm’s operations team may not be staffed sufficiently to support collateral initiatives in the current environment due to the increased operational burden of more margin calls and substitutions. Volumes and the sheer complexities associated with these changes may prove a difficult task and require some firms to seek automated solutions that offer workflows and help promote straight-through processing (STP) and exception-based processing standards.
· Inventory Management: Buy-side firms need to be able to pool collateral assets within legal entities, client accounts (funds), funds they manage, and trading strategies. The ability to view pooled assets that are with one or more custody banks is critical when determining the best use of assets.
· Collateral Trading: Firms must be able to leverage internal direct lending and/or service providers or agency lending desks in order to proactively trade assets and generate revenue.
· Collateral Transformation: Buy-side firms with a wide range of assets may want to work with service providers and banks or futures commission merchants (FCMs) to upgrade less liquid, more cost-effective assets to the higher quality, more costly assets required in the OTC derivative and futures businesses. However, a buy-side firm must consider if collateral transformation is a viable option for its business and potentially the market as a whole.
· Collateral Optimization: The buy side will develop collateral optimization as an opportunity to help reduce costs. Collateral optimization techniques are critical to a buy-side participating firm in understanding opportunities available to maximize cost savings. The optimization solution they seek will be an automated system that provides both sequential and numerical approaches that align with a buy-side firm’s optimization goals to maximize the use of collateral assets across eligible agreements.
Our latest white paper, The Changing Environment of Collateral for the Buy Side, looks at what is driving the changes in the uses of collateral, the key opportunities and constraints the buy-side is facing, and the role of technology in helping firms find new competitive advantages in the changing environment of collateral.
On a global scale, buy-side firms must look at building a new environment associated with collateral management – one that uses technology at its core strategy and supports target operating models designed to increase revenue and simultaneously drive cost and operational efficiencies.
