Tri-party collateral management creates significant efficiencies for dealers and buy-side firms as they look to manage and optimize their collateral allocations. In a recent DerivSource webinar, Joseph Spiro, director, NY head of collateral at Société Générale, discussed the benefits and adoption of tri-party collateral management services.
Margin requirements for non-centrally cleared derivatives under the European Market Infrastructure Regulation (EMIR) and Basel Committee on Banking Supervision and the International Organization of Securities Commissions (BCBS-IOSCO) are driving an increase in the use of tri-party agents to intermediate the exchange of collateral.
Tri-party collateral management borrows from the long-established idea of tri-party repo, and enables dealers that are subject to the ISDA Standard Initial Margin Model (SIMM) to post and collect initial margin in an efficient way.
In the tri-party construct, the pledger has at his chosen custodian an account referred to as the “long box”, holding assets owned by the pledger. On each day, both the pledging party and the secured party will communicate to the tri-party custodian the full amount of collateral required for that day. That amount is known as the tri-party required value (RQV). The custodian receives that message from both parties, matches them together, and then allocates that much collateral from the long box to meet the requirement. The custodian does that in a manner that is defined by a schedule based on a rule set (eg. cheapest to deliver, etc) defined by the pledging party at the outset of the agreement.
Tri-Party Enables Efficiencies, Collateral Optimization
The tri-party arrangement is extremely operationally efficient, because counterparties do not have to make multiple individual wires of collateral. It also allows firms to optimize their usage of collateral by posting cheapest to deliver first, based on what is eligible and available. The tri-party custodian can typically reshuffle that posting as needed each day—or even intraday. As different requirements come in, they can pull back certain collateral assets from some accounts and replace them with others. As long as it is eligible collateral, the tri-party custodian has discretion to do that. This is a very efficient way to operate and to optimize collateral.
“The tri-party arrangement is extremely operationally efficient, because counterparties do not have to make multiple individual wires of collateral.”
Some of the largest buy-side institutions are already involved with tri-party agents through their tri-party repo activities. These large players who are already significant providers of liquidity through the tri-party agents—and for whom the requirement to post initial margin comes earliest—are good candidates to be the first buy-side players to take advantage of tri-party collateral management.
Just how much the use of tri-party agents will spread beyond those players in response to mandatory initial margin requirements remains to be seen, but the schedule currently in place means there is still some time before much of the buy side is affected. It is unclear whether incoming political regimes around the world will either alter or eliminate that schedule, but as it stands, the vast majority of buy-side institutions probably have until 2019 or 2020 before the initial margin requirement applies to them. By then, all the other entities—the bigger firms putting systems in place now—will have ironed out the wrinkles and it will be a well-established process.
Making use of tri-party services will create significant efficiencies for all players that use them, both buy side and sell side. Though it adds an intermediary, it is much more efficient than making individual cash and security wires for every single movement. While the adoption will likely be gradual as initial margin requirements are phased in—and detailed Credit Support Annex’s (CSA’s) need to be hammered out with the tri-party agents, which can take time—eventually even the smaller firms will potentially be able to optimize their collateral management in this way.
