John van Verre, global head of custody and treasury at HSBC, talks to DerivSource about the technology challenges firms face as they try to optimize collateral for cleared OTC derivatives trades. He discusses his firm’s newly expanded collateral service, launched in May, how it will give firms an overview of their global inventory, and help firms deal with a potential securities shortfall.
DerivSource. Can you briefly describe HSBC’s newly enhanced collateral offering which was launched earlier this year?
Van Verre. HSBC’s Securities Services entity launched its OTC Clearing Collateral Service in May, expanding the collateral management capabilities within its derivatives management solution in response to new requirements under the European Market Infrastructure Regulation (EMIR) as well as a number of regulations in Asia. The platform independently calculates and verifies margins and interest, automates clients’ margin obligations linked to the specific clearing venues they use, and includes enhanced reporting back to clients provided online through the HSBC client portal, including underlying trade and collateral position information. Collateral movements are processed on a straight-through basis using SWIFT links with custodians.
DerivSource. What are the main challenges today and how will the service help them?
Van Verre. In the past, firms were allowed to use custodians to hold securities they wanted to post for collateral, but EMIR prohibits cleared collateral being held by a custodian. As firms increasingly need to deal with multiple brokers, trading venues, and central counterparties (CCPs), and mobilize collateral on a global basis, it has become difficult to know where their assets are and how they can use them. Managing all those data streams on an intraday basis has become a major technology challenge. But many clients do not have a sophisticated infrastructure in place, as there was previously no need for it. Firms need to decide whether to invest in an in-house technology and information platform, or whether to outsource to a third party.
Services such as ours can provide the knowledge base, global access and technology they need to support this. Our service allows clients to move collateral to different parties, consolidates all the information, and reports it back to the client so they just get one bill. It provides the clients with a clear overview of where their assets sit, and enables them to mobilize their collateral in the most effective, fast, and cost-efficient way.
“At many firms, the collateral management function is moving from operations to the front office. If firms don’t have clear sight on where their assets are and where they could be used, they might not be making the optimal investment decisions, or could incur avoidable costs.”
At many firms, the collateral management function is moving from operations to the front office. If firms don’t have clear sight on where their assets are and where they could be used, they might not be making the optimal investment decisions, or could incur avoidable costs. Say a firm needs to post collateral for a trade in Europe, but does not have any liquid assets available in that region. They could transfer the eligible collateral from their Asian fixed income desk for example. If they can get that in place quickly enough, they will get the best deal for their portfolio and avoid the cost of doing a transformation deal, or having to go to the repo market.
DerivSource: How do you see the demand for collateral developing? Will there be a shortfall as predicted?
Van Verre: Under Basel III and Solvency II, banks and insurers are required to hold high-quality liquid assets. This could lead to there being fewer high-quality liquid assets actually in the market. At the same time, there is an opportunity to increase the number or the type of assets that are eligible to be used as collateral, which could ease pressure on this potential shortfall. However, if you go down the route of accepting equities, that will always be done with a haircut, which would increase the cost of providing collateral. It’s a Catch-22.
It is likely that transformation will become more important if the market does face a shortfall. There are parties that are long-term holders of high-quality liquid assets, who are not entering into OTC derivative contracts and who have little skill in that area. Those entities have an opportunity to increase their performance in generating incremental returns by making those assets available at a price to parties who are facing a shortfall. But it is not certain at this point that there will be a shortfall.
DerivSource: At the moment, the US is ahead in terms of implementation, while the EU recently delayed the introduction of collateral rules for uncleared swaps until the end of the year. What impact do you think this will have on the industry?
Van Verre: The impact will probably be limited. The real issue with uncleared swaps is the requirement for higher margins. People know it is coming, so they have already made their decisions based on that requirement. The fact it has been delayed gives them a little more time, and they don’t have to put up those higher margins on the day they originally anticipated, but the delay does not fundamentally change anything.
DerivSource: How will you differentiate your offering from others?
Van Verre: We deliver an end-to-end integrated post-trade solution, enabling users to interact with brokers, post collateral, and providing reporting back to the client on their inventory. We bring together all the brokers, locations, CCPs in a way that makes sense to a client, ensuring they remain in compliance and are able to make the best decisions.
We are also developing capabilities to support an optimization / transformation process. Only time will tell if there will be a shortfall, but if there is, firms will need solutions to optimize their collateral. They will need an up-to-date view of their inventory, regardless of the location. As part of the overall solution, we will offer a rules-based system, which selects collateral based on a particular broker, a particular CCP, and the eligibility criteria for particular types of instruments, and maps the results back against the client’s inventory, categorizing them based on a client’s preference and internal policies with regards to risk appetite, operational process, what type of assets they would like to use first, and what costs are involved for moving certain assets.
The system will suggest a potential usage of a firm’s portfolio for collateral purposes based on their own criteria. If they don’t want to use a particular eligible collateral for any internal reason, they could link to a transformation service instead, enabling them to take other instruments and do a transformation, so they get the appropriate collateral for the transaction they need to support.
