As growing collateral and capital requirements push up demand for High Quality Liquid Assets (HQLAs), firms turn to collateral optimisation tools to automate the process of allocating inventory in the most efficient and effective way. Ted Allen, director of business development at Apex Collateral, FIS’ strategic solution for enterprise collateral management, explains.
Margin rules for OTC derivatives, the Securities Finance Transaction Reporting (SFTR) framework in Europe and FINRA 4210 in the US have kept collateral managers very focused on compliance during 2017. Variation margin rules have already come into force and initial margin requirements will continue to be phased in over the next two to three years depending on company size. Smaller firms especially will have to perform new types of calculations, as well as be able to source collateral, negotiate new Credit Support Annexes (CSAs), and set up accounts with triparty agents to ensure collateral is segregated. In addition, new reporting requirements around securities lending and repo will affect all European institutions and European branches of international institutions from 2018.
Many firms are looking to move away from tactical solutions to a more strategic infrastructure, in an effort to deal with these new challenges more efficiently. Rather than increasing headcount, they are looking at what improvements can be made to handle a three to five times increase in the volume of collateral calls, or which tools can be put in place to ensure both compliance and efficiency across a number of different business lines.
In many cases, firms are centralising their collateral management operations—moving out of silos to a broader enterprise-wide approach, which requires them to adapt their processes. The idiosyncrasies are different for different businesses, and there are real gains to be made by automating as much of those processes as possible with smart, intuitive tools.
Ensuring seamless connectivity
Firms can greatly improve their overall collateral management efficiency by ensuring proper connectivity to collateral utilities, triparty agents, reconciliation platforms and messaging platforms as well as central counterparties (CCPs) and custodians. Centralised repositories of legal agreements and of standard settlement instructions (SSIs) are becoming more prevalent. The infrastructure has matured and firms need to make sure they are able to connect seamlessly to it, to aggregate data flow between the organisation and those market utilities as smoothly as possible.
FIS offers out-of-the-box connectivity to a range of market utilities, meaning users do not have to react to every change in communications standards or APIs between themselves and the utilities. For example, each CCP has a different format of either an API or a simple report, which firms need to feed into their collateral management systems. Because there are no global standards and each CCP has a different process or format, it is very challenging for firms to create that connectivity with each of these different utilities and to maintain them as the standards evolve. A vendor, on the other hand, can provide and maintain those connectivity standards as they evolve, doing the work once and providing it to all their clients, rather than each client having to do it individually.
Demand for HQLAs grows
Firms today have to find and fund a huge amount of extra collateral that will then be tied up, impacting their overall liquidity. At the same time, Basel III introduces changes to capital requirements including the new liquidity coverage ratio (LCR) and net stable funding ratio (NSFR), which again increases the amount of capital firms need to set aside.
Many firms have stuck with cash collateral over the last couple of years because it was operationally simple and low interest rates kept costs down. However, this dynamic is changing because of growing collateral requirements, combined with a lowering of the relative cost of non-cash collateral as quantitative easing is cut back. As the relative cost of using non-cash collateral comes down, firms are looking for ways to mobilise that inventory in a more efficient way.
However, there needs to be a very careful process around how to allocate assets to various activities, to ensure they are used in the most effective way. Should a particular asset be used for regulatory capital, or for collateral? If collateral, then where? When allocating collateral to specific requirements, firms need to try and minimize both the cost of collateral as well as the balance sheet impact. That means putting overnight collateral against overnight requirements, for example, which is a very complex logistical challenge. It is very difficult to do this without an automated optimisation tool in place.
Advantages of buy versus build
Some firms may want to build an optimisation tool in house, but the time to market will be much longer than using an off-the-shelf tool. Time-scales for in-house builds are usually underestimated because of the relative complexity of the problem that needs to be solved. It is not just a calculation problem—once people start to optimise the inventory allocations, there is an opportunity to automate the trade generation and collateral bookings. That piece is often neglected with in-house builds, but that is where the real operational efficiency gains are to be made.
Firms do not need to replace their collateral operations tools wholesale—they can layer a vendor-bought optimisation tool on top of their existing collateral management infrastructure. The optimisation tool brings in the requirements from the collateral operations tool and can be the source of inventory, by bringing in positions and trade dates directly in real-time. It then performs the optimisation to minimise the cost or balance sheet usage and automate the trade booking process.
FIS’ Apex Collateral can be configured to serve each firm’s cost structure, priority structure around asset utilisation, and measurement of cost. It can then perform the allocation of collateral to make sure that the inventory is deployed, whether for trading, capital or financial reasons, in the most efficient way possible.
