A new whitepaper warns OTC derivatives market participants are in for a huge increase in operational resources required to meet the burden of the growing number of collateral settlement fails.
A new whitepaper published this week estimates unsupported exposure as a result of collateral settlement failure among sell-side firms to be $27 billion. The paper “Implications of Collateral Settlement Fails: An Industry Perspective on Bilateral OTC Derivatives, which was published by the DTCC and Euroclear JV, GlobalCollateral, in cooperation with PwC, highlights how both the costs and risks associated with collateral settlement fails will increase due to anticipated surge in volume of margining activity driven by the new rules for bilateral clearing of OTC derivatives.
Collateral settlement fails, which occur when collateral is not delivered or received by the agreed date between counterparties, is certainly not a new issue for market participants but it has been overshadowed by the impact of regulatory reform in recent years, Ted Leveroni, Chief Commercial Officer at DTCC-Euroclear GlobalCollateral Ltd, told DerivSource. The knowledge of this silent threat to the industry is what drove GlobalCollateral to investigate the longer terms costs and implications for the market in the whitepaper.
“This whitepaper is important because [collateral settlement fails] impact everyone and have real risks, but [as an issue] it has been overshadowed by regulation,” he said.
A significant finding is the explosion in the operational costs required to resolve such collateral settlement fails of bilateral OTC derivatives. Specifically, the paper estimates that the average annual operational cost of remedying settlement fails for survey respondents could increase 407% to $3.6 million for each buy-side firm and 377% to $2.4 million for each sell-side firm by that 2020. Of course additional resources will also be needed and the report estimates the number of full time buy-side firm employees will increase from four employees in 2015 to 24 employees in 2020 whereas for sell-side firms on average, the expected increase will be from three employees to 16 during the same time period.
The predictions in the whitepaper are based on information gathered through interviews with collateral settlement specialists in the OTC market and include a mix of different types of firms such as asset managers and dealer banks.
Firms need to be aware of the increases in operational resources and costs needed in the future to manage the burden of collateral settlement fails they should start preparing now, Leveroni told DerivSource.
“This [whitepaper] gives the opportunity to go to the management with real evidence, get budget, and save money by addressing the issue now and taking risk out of the system, too,” he said.
Please read the whitepaper for more details, which you can find here.
