Collateral management has been at the forefront of operational investment for several years, thanks to financial regulation. As a result, new technologies have been developed, alliances between market participants established, and previously manual processes automated. In a Q&A, Lombard Risk’s Tina Wilkinson discusses the new collateral management ecosystem and how all market participants can leverage a newly connected market to gain operational efficiencies and a competitive edge. Join related webinar Nov 16th to hear more!
Q: Lombard Risk has witnessed the rapid transformation of the collateral management space in the last decade. What does the new collateral management ecosystem look like today and how is it different from the past?
A: Before the financial crisis of 2008, collateral management was really part of the back-office function. Now we have new participants, and new asset classes. The buy side is now heavily involved, where previously they had less influence on the collateral management process, and many of these firms have had to change their entire business process to comply with looming regulations. The collateral process was often siloed, and there was little front-office revenue focus on collateral management unlike there is today. As the cost of collateral and volume of collateral transactions have significantly increased, there is now a drive to manage collateral more cost-effectively and efficiently.
There has been an overall improvement in collaboration between key infrastructure providers from the front office to the middle office, where a majority of the collateral management processing is performed, and through to the settlement process. The key objective of every firm is to have a clear view of the collateral available to them, and the ability to optimise the use of the collateral to generate revenue from the various segments of the collateral management process. Firms are looking for integrated solutions that enable that streamlined front-to-back processing and improve their time to market.
“There has been an overall improvement in collaboration between key infrastructure providers from the front office to the middle office, where a majority of the collateral management processing is performed, and through to the settlement process. The key objective of every firm is to have a clear view of the collateral available to them, and the ability to optimise the use of the collateral to generate revenue from the various segments of the collateral management process. Firms are looking for integrated solutions that enable that streamlined front-to-back processing and improve their time to market.”
In order to facilitate this process, Lombard Risk partners with best in breed platforms, bringing together the infrastructure that is necessary for its buy and sell-side clients. The goal is to bring buy and sell-side counterparties together, and shorten the process between collateral posting and collateral settlement. For example, Lombard Risk has partnered with Elixium on the repo side, and DTCC Euroclear Global Collateral—a joint venture between The Depository Trust & Clearing Corporation (DTCC) and Euroclear—to enable the settlement process and confirmations to be taken back into its collateral management system. This provides clients with a real-time view of their inventory, enabling them to enter the portfolio optimisation process more effectively.
For many on the buy side, new regulations have brought a degree of complexity that they didn’t have before. Many of them are looking at cash-only movements, which in itself can be a challenge for those buy-side firms that have historically been low on assets. One of the benefits of working with Elixium from the repo perspective is giving firms that access to liquidity.
For any firm, using cash only can be expensive. It is a capital charge, and so enabling firms to better utilise their other assets is becoming more and more important. Bringing the buy side closer to the sell side allows them to utilise repos to generate revenue and get access to high-quality liquidity. It also allows them to post their equities for securities lending. Simplifying this process is imperative. The typical buy-side firm is graded on their portfolio trading and asset allocation, but collateral optimisation is not a typical core competency within an asset management firm or pension fund. Bringing them together with their counterparties, and providing a solution that gives them access to better utilisation of their collateral, aids their bottom line immensely.
Q: Looking internally at either of those sectors of clients, whether it’s buy-side clients or sell-side clients, what are you seeing in terms of changing trends for their internal collaboration?
A: On the sell side, there is a trend towards centralisation of the collateral management process. Previously the OTC desk managed their OTC processes and the repo and sec lending desks similarly operated in silos. Now firms are trying to bring all of that together to create a cross-asset P&L. They are enabling much better collateral optimisation for the bank as a whole, which impacts capital charges and reduces the need for cash only as a collateral facility.
This changes the overall infrastructure requirements, because each of these various business lines has been using completely separate and sometimes internally built solutions. Now they are moving to a much more centralised process, and need to either integrate multiple disparate systems or actually push to a single system infrastructure and reduce their IT infrastructure maintenance burden.
Q: What is the biggest way the market and market participants can simplify their margin infrastructure to provide the scalability and address the requirements they need to going forward?
A: Tools such as SmartDX that enable and streamline the legal negotiation and documentation process are very useful. If a buy-side firm is trading exchange-traded derivatives (ETD) and suddenly has to trade over the counter (OTC), there is often no credit support annex (CSA) in place. In partnering with SmartDX, Lombard Risk integrates that legal documentation piece with the other solutions within its collateral tool to provide a best-of-breed, one-stop shop for collateral management.
Buy-side firms vary greatly from the very vanilla to the passive funds using repos and ETDs. There are also hedge funds using quite complex structures. These are often smaller organisations that may not have the administrative bandwidth to manage multiple systems, but are driven by the need to creatively use their assets to provide collateral. The collateral optimisation process is important for these funds, as they will not necessarily want to use their cash as collateral. The ability to use repo transactions as collateral will be essential for them going forward in this ever-evolving collateral landscape. Cross-asset systems will be increasingly important to the more complex derivatives players, as well as the passive and exchange-traded funds (ETFs) that also will now need to post collateral.
The sell side’s current focus on client profitability, and the fact they need to provide their services to hedge funds and passive funds that do not have a large administrative or operations team, is driving the need for a multi-asset class collateral management solution as well as a supportive infrastructure for all the information that needs to come in to provide a real-time view of inventory and enable the settlement process. That collateral “highway” is essential to the buy side, but potentially even more so to the sell side, which is typically more adept at managing such complex transactions.
Q: What benefits would they achieve through addressing complexities? Please give examples.
A: Many firms are focused on automation, but this is sometimes less about cost reduction and more about improving client satisfaction. For some firms, the ability to automate processes to post margin calls earlier in the day, without the need to touch transactions, is quite important. It gives the buy-side counterparties time to actually analyse what assets they have available to post and select the best assets before the settlement specifications kick in.
Q: Why is it important that the industry remain connected and work together when addressing collateral management challenges? Does Lombard Risk have established alliances?
A: The days of thinking you can build this or buy it from a single provider are gone—no one can build everything. Collateral management is a complex process. The asset classes involved, the nomenclature from one asset class to another, and the users within a business are all different. Someone working in the repo area will have a completely different way of working than someone on the OTC side, and that will be different again from someone working in the ETD space. Trying to be everything to everyone as a vendor is not practical.
“Vendors need to work together to support their clients. Over the last few years, firms that traditionally felt they were competing realised it is more cost-effective for both providers and end clients if they collaborate. Lombard Risk believes a partnership approach is the best method, and has had positive feedback from the industry on this.”
Vendors need to work together to support their clients. Over the last few years, firms that traditionally felt they were competing realised it is more cost-effective for both providers and end clients if they collaborate. Lombard Risk believes a partnership approach is the best method, and has had positive feedback from the industry on this. Lombard Risk partners with vendors such as Elixium, SmartDX, and the DTCC-Euroclear GlobalCollateral joint venture, that are the best at what they do in the areas our clients—and their respective clients—need.
Q: What about cloud technology? How does this fit into the new collateral ecosystem? Are there other types of technological innovation that firms can use in their collateral operations?
A: Much of what we’re looking to provide with partners is available in the cloud as well as installed solutions. From the buy-side perspective in particular, the ability to host and work with our partners in a cloud environment means that they don’t have the infrastructure costs. It means we can manage their upgrade process, address any technical concerns they may have, and potentially reduce their operational costs as well. We are now also seeing some of the larger organisations starting to review whether it works for them. Many are seeing potential security benefits to a cloud environment, and are also interested in the performance benefits and scalability options as well.
Q: Collateral has historically been a cost for firms, how can this area differentiate firms and deliver a competitive edge going forward?
A: Optimisation means different things to different people: whether it’s trade optimisation; inventory optimisation; the actual collateral asset optimisation; or even for some now that are only dealing with cash, it’s looking at funding rates, reinvest rates, and operational costs.
The buy side will often look at their own internal strategies as opposed to just the cheapest-to-deliver parameter, which many people think defines the term optimisation. From our perspective, we’re trying to offer as much flexibility as possible within collateral parameters, industry parameters, and availability sources. That is one of the benefits of being able to support internal availability pools, as well as the linking to the global collateral highway in terms of the real-time movements of assets across jurisdictions and guaranteed settlements.