Alistair Griffiths, director EMEA sales at Baton Systems, shares the obstacles firms face when seeking to automate currently manual processes within collateral management operations. Read on for insight into how improving three areas of collateral management processing – visibility on transaction status, inventory, and data aggregation – can deliver the cost savings and efficiencies that validate technological investment today.
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All too often a major obstacle to automating the ever-more important collateral management process is the cost and perceived benefit of the technology investment. The processes firms currently have in place might not be perfect, but they fulfill a need, and firms may question the need to invest. For the most part, individual elements of the collateral management process are not overly complicated in isolation, however, when considering the end-to-end flow this becomes a complex operation (with numerous points of failure) that requires either automation or an army of people to manage it.
Why the time is now for automating collateral management
Automating manual processes has made sense for a long time. However, the level of competition in the market today is making it a bigger priority. As new supply comes to the market, firms have a variety of options in terms of agent lenders. Lenders have options in terms of borrowers and brokers. Firms need to have something in their toolkits that outperforms their competitors and differentiates them.
There are a variety of levers that can be pulled. For example, a firm could take collateral under a pledge arrangement, expand its collateral schedules, or move into the cleared space. These all play a major role in moving the business forward, but they are not greatly different. If clients have more options about where to go or who to use, firms need to look at how they can become the lender or borrower of choice. The smoother operating solution will reduce downstream issues such as fails/reconciliation breaks and will lead to a more fruitful long-standing relationship. As demonstrated by the advent of the Central Securities Depositories Regulation (CSDR), failed trades cost money and in some cases, the levied penalties have been eye-watering.
“If clients have more options about where to go or who to use, firms need to look at how they can become the lender or borrower of choice.”
Firms with enhanced collateral management systems have a better view on what assets are available in conjunction with their location and, with a swift route to market, find themselves in an advantageous situation vis a vis their more ponderous competitors. The identifiable data set is also likely to be more accurate therefore making the most optimal use of assets, whilst meeting obligations and margin calls an achievable target with obvious financial benefits.
Operational challenge 1 – boosting transaction status awareness
One driver for automating collateral management is the need to have a handle on margin requirements and collateral on deposit. Without proper visibility of these key elements, firms can’t take appropriate action, may be operating blind, and could be bringing significant risk into the process.
“Without proper visibility on transaction statuses, firms cannot take appropriate action, may be operating blind, and could be bringing significant risk into the process.”
To state the obvious , firms need to be able to meet their margin calls and that requires sufficient accurate visibility. The right asset needs to be in the right place at the right time. Firms need to have streamlined processes whereby swift seamless transfers can occur without the afore-mentioned army of people manually booking transactions. The whole process right now can be incredibly slow. Assets could be held across multiple different tri-party agents and numerous custodians. Being sufficiently long eligible securities may not suffice if they are encumbered elsewhere or unavailable for use. For instance, if there is a corporate event on an asset that would usually be eligible therefore rendering it as zero value in terms of collateral usage.
Firms know they must meet their end requirements, but they constantly have to stop and check something or call someone—for example, to find out where the asset is, or whether it has settled. This becomes especially problematic whenever there is a stress event because there is less time to get everything done. Firms may fix this issue by manually reviewing transaction status which is laborious and overly time-consuming. Would it not be much easier if there was a single source of truth enabling firms to see their inventory and all movements in near real-time?
Operational challenge 2 – real-time aggregated view (crucial for stress events)
When the Russia/Ukraine conflict began in 2022, many firms were scrambling to find out what their exposures were to Russian entities on the sanctions list. Doing this by phone meant firms risked having an incomplete picture. An aggregated view of a firm’s inventory and holdings would have made assessing those risks much easier and faster.
The threat of a US default has also driven firms to look at their collateral schedules. Many of the securities being utilised at clearinghouses to meet margin are US treasuries. If there had been a default, a large part of the market would no longer be eligible to meet margin and firms would have to immediately find alternatives. If the debt ceiling had not been suspended, that would have negated billions of dollars worth of collateral that firms are currently employing. Firms may need to find alternative sources of collateral very quickly, and this will be very difficult to do without an aggregated view of inventory.
If a firm doesn’t have much time to fix a problem and can’t see what inventory it has where, or what is the status of transactions, it is difficult to accurately run the business in a risk-averse, profitable manner. Having sat in the seat when a Chief Risk Officer asked me to detail exposure to a specific country and entity I can assure the readers that reliance on disparate systems and communication methods makes it extremely challenging to give an accurate timely response.
Operational challenge 3: aggregating and normalising data to improve the visibility of assets
Continuing the theme of visibility, the following example illustrates the value of aggregating and normalising data to improve decision-making. Let’s say a firm has relationships with five tri-party agents, 10 central counterparties (CCPs), and three custodians. They have collateral on deposits or unencumbered assets held at those locations. These are all recorded as separate lines of data and the firm receives 18 different reports with different data fields and formats providing information on the firm’s holdings. The reports come as a PDF, a CSV, or .xls spreadsheet to name but three formats. Two custodians have different naming conventions for the same asset, asset type, or identifier. All this data must be aggregated and normalised to get a total view of the firm’s holdings. Firms can attempt to either do this themselves or use a tried and tested solution such as the one developed by Baton Systems.
Baton Systems users can view the data in the user interface, or they can pipe it straight into their back-office systems (via API) in a format that is convenient. Firms then have an up-to-date, normalised, and aggregated view of what they are holding, enabling them to enhance their decisions from both an optimisation and speed perspective. When considering optimisation, the chosen engine can look at everything at once, rather than doing it 18 times (a siloed approach is never optimal).
The benefits – lowering costs and the opportunity to generate alpha
A major reason for bringing assets into lending programs is to reduce the total expense being charged by their service provider. But firms can also generate alpha as they lend those securities out. From recent market discussions, it can be deduced that frequently there is an excess of collateral of about 20% across CCPs. While some excess is necessary to insulate firms from sudden price fluctuations, a 10% excess might be considered sufficient.
What else could firms do with that additional 10% if they had better control of their inventory? They might put it in the overnight repo market, buy money market funds or utilise those securities in another way that is revenue generating. However, the last thing firms want to do is fail on a margin call. Due to the fact, they lack the information to do this in a more strategic manner, firms may choose to employ large amounts of high quality liquid assets (HQLA) or add cash buffers to ensure they do not default at the CCP.
Next steps – address the resistance to change
As mentioned at the start of this piece there is an element of not wanting to rock the boat. The mindset could be considered as, “get it done, keep the lights on, keep moving forward at the same pace.” Without exaggeration, certain systems employed by major organisations are 30 years old. They might be (just) fit for purpose, but can they provide a realistic path to cost-efficiency or optimisation? Firms could look to rebuild the connectivity to all their CCPs although this is a painstaking process. Replacing their existing infrastructure would be a significant investment and a multiyear project, and few people have the appetite for tying their personal capital to a project of that scale.
It is also not necessary. A third-party system, like Baton Systems’ Core-Collateral, can provide the integration, data aggregation, and normalisation that firms need to be able to upgrade their collateral management operation without a major infrastructure overhaul. Firms can plug data into their own platforms, while Baton runs the upstream processes. Instead of a risky three-to-five-year infrastructure project, they can be up and running using a proven technology within weeks. Instead of building connectivity to CCPs one by one, they can use a plug-and-play solution and be up and running within a much shorter timeframe.
Firms should look at their operations and determine whether their current model constrains future business in any way. If a particular desk landed five or ten new clients and expected volumes to go up significantly, would the operational function be able to handle this? How can they future-proof their business now so they can continue to adapt and grow?
In conclusion, the available technology should ensure that business models and strategies can be executed without needing to upscale in terms of personnel and/or increasing the risk landscape. Baton Systems offers organisations the ability to aggregate data from disparate sources with an eye to efficiently and optimally use assets in the chosen location. Just like the age-old, and at times loved fax machine becoming ever more obsolete, it’s time to kick to touch the need to invoke archaic procedures involving spreadsheets, macros, and other manual error-prone steps.
