In a webinar, collateral management experts explored collateral optimization strategies and attendees sent through numerous questions. A Webinar speaker, Etienne Ravex, Product Manager at Murex, addresses some of those attendee questions below.
Question: How do you measure the effectiveness of optimization activities and what are some best practices for doing so?
ER: When it comes to measurement of optimization, it might be worth to consider which element is at stake and to what extend one can act on measured results.
For pre-trade optimization, a couple of directions could be explored including:
– All-in pricing impacts:
- Compare P&L and cost attribution before and after deployment of such capabilities
- Assess evolution of Interest Rate Swap desk activity in volumes
- Review number of disputes to due valuations discrepancies
– Initial Margin (IM) impact:
- Re-run simulated IM requirements on predefined Broker+CCP schema (e.g. based on past activities) Compare to actual IM requirement and split across Broker+CCP
For post trade optimization, there are some key benchmark capabilities that are de facto in the optimization process such as Cheapest to Deliver (CTD) determination or rebalancing of inventory. Indeed by defining the optimization targets, one defines at the same time the initial / reference state of the collateral inventory and its return, therefore the outcome of the optimization is a direct measurable metrics. And by changing the constraints and targets in ‘what-if’ context of this optimization, one can assess the corrective impact which means the outcome is not only measurable, but corrective actions can be taken if required.
Lastly with regards to operational efficiency, many standards metrics can be used to measure efficiency gains including: the number of calls processed per employee, elapsed time from margin calculation to settlement; number of disputes and related time to resolution, and ratio of STP calls.
Question: Why do pre trade optimization tactics differ between sell side as compared to buy side?
ER: Regarding collateral optimization, the main difference between the buy side and sell side is around timing & constraints. By being less constrained e.g. on the IM requirements front or on the liquidity ratio front these problematic used to be less “core” attention to them. This being said, many buy-side firms are currently working on optimization and so we could make the fair assumption that convergence between buy side and sell side will increase over time.
Question: Do you foresee major renegotiations of CSA’s to include a wider spectrum of collateral?
ER: It is a difficult question. On one hand side, there will always be a need to adapt current CSA framework in place to the post BIS / IOSCO environment and given the market changes, the need to conduct further renegotiations could be challenging.
On the other hand, firms should conduct careful analysis on existing schedule in place, as the eligibility terms might not be used to their full extent. Hence, a potential first check should be reviewed internally if current framework is optimally used.
Question: Repo clearing do you think that would pick up in lieu of collateral optimization?
ER: We would rather consider that an efficient access to repo market would be key to achieve some part or the collateral optimization equation such as collateral transformation, diversification of assets, and sourcing of eligible assets. From this perspective, we should first focus on how the dynamic around tri-party repos servicers, repo clearing, and shadow-banking regulation will evolve and possibly impact securities finance market and by way of consequence collateral optimization.
Question: Will eligible assets for variation margin (VM) be restricted to cash in the same currency as underlying swaps in line with new regulations or is it merely a funding consideration?
ER: Here are some of the requirements. For uncleared trades:
– As per BASEL III (here) standard haircut schedule does not enforce VM to covered in cash only; not to say this is the same ccy as underlying assets
– CFTC transcription as per ISDA last analysis (here) mentions that for VM firms are expected to post VM in cash only (USD or swap settlement currency). But this is also flagged as an open point as it could lead to cross-border issues.
– Indeed, in European Union, latest RTS document specifies that:
- Non-cash collateral is eligible for VM
- And that x-ccy haircut would not apply for cash settled VM
As of today, I suggest the industry should consider a framework whereby:
– VM collected under CFTC rules would not be subject to optimization as being “prescribed” by regulation as USD; or swap ccy
– VM collected under UE rules would be subject to optimization
The VM discrepancy is expected to generate extra cross-border complexity however; hopefully more harmonization is to come.
* You can watch the On Demand webinar “Collateral Optimization: Techniques for both Pre-trade and Post-trade“
