Collateral management has come a long way in the last decade. Regulatory change impacting both cleared and uncleared derivatives has driven investment into this traditionally post-trade operational unit. Despite making big strides in reducing operational inefficiencies, many financial institutions lack visibility into their collateral inventory across venues and asset class silos. In a Q&A, Alistair Griffiths, director of EMEA sales at Baton Systems, explains why the collateral managers today should be focused on establishing transparency into their entire collateral inventory and how doing so can fuel significant improvements in collateral mobility and efficiency for the benefit of the entire business.
Q: How do firms typically view their collateral inventory across silos, venues, and business units today?
A: There is a range of methods and views the industry has taken. Some firms have an almost holistic view and have solved for optimisation, while at the other end of the spectrum, there are firms that have silos of businesses that do not communicate with one another. For example, the equity desks and fixed income desks within a firm may use the same tri-party agent but operate under different accounts and possibly even different legal entities that do not speak to each other.
Even the firms that have solved for optimisation have at times done this in a fairly limited way. They may have optimised their cleared derivatives business, their uncleared derivatives business, or their repo business, but did they look at it from an enterprise-wide level? In many cases they do not know what all their obligations are at a glance, and they are not able to see what the best use of a given asset is. Things are starting to change on this front but there is still a long way to go.
In the past, the systems used by different desks often had limited ways of communicating with one another and so it was nearly impossible to share resources or transfer assets between desks. This has changed with the rise of application programming interfaces (APIs), which enable integration between systems. Thus, firms no longer have a valid reason not to integrate with the technology available. But there may also be internal political reasons that cause businesses to not share assets—each desk has its own P&L and could be perceived as essentially in competition with other desks for institutional resources. How does a Treasury department or management board decide which desk should get which asset to employ?
Q: What are the problems with this fragmented view into collateral inventory? What risks does this lack of transparency create?
A: If a firm does not have an overview of its inventory, it may not know if a loan has been booked or indeed settled. Portfolio managers may want to sell assets that have been utilised elsewhere and it may not be clear if other obligations for that asset should be considered. Lending desks and portfolio managers are not always in alignment. Lending is not a core part of the business, whereas portfolio management is. A portfolio manager might not want their business to be impacted by the discretionary lending business and could end up selling an asset that has not yet been returned by a borrower. The firm could end up with a relationship issue between the two desks. Of course, a firm could avoid these issues if it had transparency over what inventory was in use and what was available at any given time. (Read related blog from Baton Systems here).
“Portfolio managers may want to sell assets that have been utilised elsewhere and it may not be clear if other obligations for that asset should be considered.”
Q: What are the drivers for firms to tackle this fragmented inventory management structure today?
A: It starts with risk. Firms want to reduce their operational, settlement and credit risk connected to securities lending and associated financing/collateral management activities. While they are making it work in some cases with their current systems and Excel spreadsheets, they realise that these solutions are not robust or efficient. Many institutions have been interested in optimising inventory management to improve the bottom line but wanted to ensure the cost benefit analysis would demonstrate an acceptable return. Technology providers have sprung up in this space and it’s evident there is a renewed desire to drive forward with increasingly mature and advanced solutions. As firms start to see their competitors investing in this type of technology they do not want to be left behind.
It is also about efficiency. Currently, portions of the collateral management and securities lending activity are handled bilaterally, which can involve large headcount and operational redundancy (where each desk has a team doing essentially the same thing), and can lead to huge excesses when each desk employs more inventory than is efficient. Having a top-down view of its inventory would enable firms to pool resources and take a true top-of-house holistic approach to asset utilisation. Initially this could lead to lessons being learnt from previous experience and a best practice being employed across each desk/business unit.
“Having a top-down view of its inventory would enable firms to pool resources and take a true top- of- house holistic approach to asset utilisation.”
Staying on top of regulation is another key driver. Firms are concerned about how they are going to meet their requirements from a net stable funding ratio (NSFR) or a liquidity coverage ratio (LCR) perspective. In some instances, where regulations permit, firms have prioritised making sure the numbers are within tolerance when they provide data to regulators on specific dates in the month. But the industry is now getting to the point where firms need to be in compliance at all times as opposed to only on specific dates. Firms also need to be able to keep pace with regulatory change as new rewrites are coming in across the globe. They need to think not only in terms of how much revenue they generate, but also how much those trades cost them in terms of fails or regulatory penalties. When firms are not efficient, those costs can escalate quickly. Penalties levied through the Central Securities Depository Regulation (CSDR) constitute a perfect example of this. The Bank of England’s Securities Lending committee recently stated that “…CSDR penalties are bigger than expected – and not washing through the system as easily as anticipated. Levels of fails remain high, which means the level of penalties remains high, particularly in Europe.”
Finally, it is about revenue and optimisation. A firm might trade with multiple central counterparties (CCPs), but the margin, or cost of trading with one could be higher than another. They could use that knowledge to clear trades with the most optimum CCP. With better inventory management, firms could make more informed decisions around whether to post cash as collateral or to use it for money market funds or repo, or whether to lend securities out to the market. Using assets more strategically could drive revenue in other areas. Deploying excess assets could create an entirely new revenue stream that did not exist before. By way of example, firms can also seek to analyse and employ those harder to fund securities. This could both enable previously unutilised assets to be brought to market as well as holding back High Quality Liquid Assets (HQLA) that present more value on the balance sheet and enhance regulatory capital.
“Using assets more strategically could drive revenue in other areas. Deploying excess assets could create an entirely new revenue stream that did not exist before.”
Q: How can a firm achieve an enterprise-wide cross-silo view into collateral inventory?
A: If you imagine a row of terraced houses each with a fenced-in garden in the back. From one house you cannot see what is in the other gardens. However, if you start to knock down the fences, you will start to have a better sense of what is out there. Likewise, firms need to find a way to see all their sources of collateral across all desks, custodians and CCPs.
Once they have broken down the fences and can see what they have, they need to find a way to use it efficiently. They need to have the right technology to be able to take the full view, break it down, understand what is eligible and where it is eligible. With credit support annex (CSAs) and collateral schedules related to securities lending and repo mostly digitised today, firms need a tool that can see what collateral needs to be used for which counterparty. The technology should show which assets could be used, where they could go and then actually mobilise them. Unless the platform can mobilise the asset, it is like having a fantastic looking car with no engine. It needs to provide the full picture from displaying the sources to facilitating the uses of collateral assets.
None of these pieces are easy, but more and more firms are calling for an aggregated view of their inventory to enable enhanced deployment.
Q: What is the biggest obstacle a firm faces in achieving cross venue inventory management and mobilisation?
A: Firstly, it is getting everyone to play nicely together in the sandpit. Lenders, brokers, tri-party agents, technology providers all want fundamentally the same things—for things to work well and to get paid for their part in it. For this to happen, all the players in the ecosystem need to work together, but this is not always easy in a highly competitive setting. Firms potentially don’t want to risk their competitive advantage by helping someone else’s business. Invested parties, such as a Chief Operations Officer (COO), Business Manager or Desk Head need to point out the inefficiencies of having duplicate dealer boxes, client service teams, operational functions and suggest there are alternative models to the status quo.
Legacy technology stacks are another big obstacle, and some banks have systems that are archaic with a series of bolt-ons being added over time. It is highly challenging and hugely expensive to rip these systems out and start again—few firms will get that kind of multi-year, multimillion dollar investment signed off. However, with APIs, enhanced message flows and workflows, technology firms can provide offerings to upgrade pieces of the technology stack incrementally, breaking down the ticket size, which is much more palatable for institutional stakeholders and still pave the way for achieving more efficient and cost-effective operations in the long run.
