Collateral managers will continue to be under pressure in 2019 as they work to meet regulatory obligations, and also look to invest strategically in their operations to improve efficiency and increase automation. Helen Nicol, Global Product Director, Collateral Solutions at Vermeg, which acquired Lombard Risk earlier this year, discusses the challenges that they face, and the various market solutions available to them.
Regulation continues to challenge all organisations and drive change across all regions. The first phases of the Dodd-Frank Wall Street Reform and Consumer Protection Act, the International Organisation of Securities Commissions (IOSCO) and European Market Infrastructure Regulation (EMIR) rules have come into force, as well as the Markets in Financial Instruments Directive II (MiFID II) and the Securities Financing Transactions Regulation (SFTR). Next year will see the introduction of the Financial Industry Regulatory Authority’s Rule 4210 (FINRA 4210), and the next phases of uncleared OTC initial margin requirements will come in September 2019 and September 2020. For uncleared OTC derivatives, the phased approach continues, and according to data gathered by the International Swaps and Derivatives Association (ISDA), this could potentially see an additional 1,000 counterparties impacted, and 9,000 new trading relationships come into scope.
The Commodity Futures Trading Commission (CFTC) is currently seeking comments on proposed amendments to these rules. Many buy-side organisations are therefore waiting to see whether they will actually be impacted by the additional margin requirements, or whether the thresholds and notional obligations change.
On the cleared side, the deadlines are also coming into place for mandated clearing, for both interest rates swaps and credit default swaps (CDSs). Some buy-side organisations are choosing to opt in earlier than the proposed timeframes, in order to get their own internal structures and processes in line.
Finally, uncertainty around Brexit has a significant impact on the regulatory perspective. A hard Brexit with no new trade deal would mean no retention of open access to the single market, and crucially no guarantee of the EU passport for UK-domiciled banks. A lot will come into play over the next 12 to 18 months. The one thing that all organisations are looking at is the time to market in terms of meeting all those deadlines. Preparation is the key.
Preparing for mandatory clearing
Mandatory clearing began for the sell side in 2016 and has rolled out with different levels of success. The central counterparties (CCPs) set initial margin to reflect their estimate of the riskiness of the underlying transactions.
For the buy side, the main challenge is that they don’t have direct access to the clearing houses, although organisations such as LCH and Eurex are trying to offer that. This means that the buy side needs to engage with several dealers, some of whom are withdrawing from offering client clearing services.
Even when direct clearing is available, quite often the buy side doesn’t have the infrastructure required to provide connectivity to those CCPs. They don’t have the APIs (application programming interfaces), or the large technology teams. They will often rely on engaging a dealer to provide those clearing services for them. Several fund managers still don’t seem to fully understand all the requirements, and the access to the market and inter-party dealings that they need to agree.
For many fund managers, access to non-cash assets is very important. Ultimately, liquidity will be one of the main determinations for where and with whom the buy side clear. However, several of the larger dealers have moved out of offering client clearing solutions for the very small clients, where there is only 10, 20, or 50 trades, as it is simply not cost-effective for them.
Fortunately, there are now some new participants coming into the marketplace that are offering hosted solutions for client clearing, removing the infrastructure obligations and making it more cost-effective for them. They are gradually starting to roll out across existing and additional CCPs on a global basis, and across multiple different products including interest rate swaps and CDSs. There has been some uptake on this from buy side firms that fall under the cleared derivatives mandate.
Regardless of whether an organisation is large or small, automation and increased levels of straight-through processing (STP) are vital, as the volumes and the levels of complexity increase across all asset classes.
Looking ahead to 2019 and beyond
Regardless of whether an organisation is large or small, automation and increased levels of straight-through processing (STP) are vital, as the volumes and the levels of complexity increase across all asset classes. Often, antiquated infrastructure remains within the firm and acts as a hindrance to achieving the required levels of automation. This creates an additional burden on a potentially already overloaded resource.
Collateral operations professionals and teams will need to expand their skill sets across treasury, settlements, and reconciliation, in an effort to combine all asset classes and deliver streamlined workflows. Connectivity to internal and external platforms has been a very hot topic over the last few months, as people try to automate as much as they possibly can, leaving their teams to act as value-add for those exception-based processes.
Teams are looking for integrated inventory solutions across all regions, so that they know at all times where assets are located, whether they sit in segregated accounts with custodians, tripartite agents or internal structures. Once firms have access to their inventory and realise where the assets are sitting and how easily they can be moved across regions and jurisdictions, they have the ability to look at optimisation from a cost perspective, and also, particularly with the buy side, from a client strategy, counterparty or fund strategy perspective.
Access to robust technology is crucial, and a number of organisations that traditionally have built in-house, are now looking to take modular provision from some solution providers, whether that’s a vendor or an outsourcing platform, in order to boost their own internal piece. They may not take a whole solution, but they will take pieces of it as they are recognising that the cost for support and maintenance of these platforms can be quite substantial.
Automation can mean different things to different firms. Smaller organisations are more concerned about the issuance of the actual margin calls and the booking of settlement processes. For others, it means things like increased levels of APIs, perhaps hosted solutions. Distributed ledger or blockchain has been a hot topic for some time. Now we are seeing a move to AI, and certainly some of the larger organisations are looking at asset selection based on AI functionality.
There has also been an increase in demand for micro-services, where areas within large organisations need access to data held by collateral systems, but don’t necessarily need access to the collateral piece itself—for example, legal documentation, transaction reporting, securities and pricing data. Access to all that data is becoming fundamental to everybody.
2019 will see more progress, and more focus on strategic investment for collateral managers across the board. If firms are to keep up with the market and the regulatory requirements, they have to look to collateral management and automation as a long-term strategy.