Putting in place a compliant and efficient collateral management solution requires ongoing collaboration between affected departments and with trusted partners and providers. Helen Nicol, global product director, Collateral Solutions at Lombard Risk discusses the strategic options firms are evaluating as they look to comply with new regulations, despite ongoing uncertainty caused by political disruptions.
Buy and sell-side firms have been working hard to prepare for a slew of new reforms affecting their collateral management and margin processes, including Basel III, the Dodd Frank Act, the European Market Infrastructure Regulation (EMIR), and the Markets in Financial Instruments Directive (MiFID) II. Firms have a variety of options open to them as they look to implement compliant and efficient collateral management systems, and many firms are well on their way to having solutions in place as deadlines loom. However, for many firms there remains a lot of work to do.
Political change has added a new level of uncertainty, as firms wait to find out if there will be further changes to new regulations. For example, on June the 8th this year, the US Financial Choice Act, passed the House 233 to 186, along party lines. This bill seeks to undo significant parts of the 2010 Wall Street Reform and Consumer Protection Act (Dodd Frank Act). Among the major changes, the bill allows banks that maintain a certain level of financial surplus to opt out of those rules, and abolishes the bailout process established for major financial institutions.
Meanwhile in the UK, Brexit and its potential impact—particularly with the recent election results—creates a greater unknown, where the discussion is not even able to begin. One thing that is clear is that the implementation of the global regulations, such as Basel III, Dodd-Frank, EMIR, and MiFID II, will bring increased capital and reporting requirements.
Basel III proposals also bring changes to credit and counterparty risk calculations, and also calls for additional collateral and margin requirements for large and liquid derivatives.
Generally, firms should continue to prepare for the regulations according to the deadline with their impact guide, as it is not clear which, if any, of the rules may be affected. This obviously generates greater uncertainty during the time when the deadlines for other regulations approach.
The process of preparing for compliance will depend upon the size and strategy of the firm and their overall experience level. Those that have been carrying out bilateral margining for years are probably fine, but firms that are settling into the world of daily bilateral margining for the first time may see additional strain.
No one department can be responsible for this alone. There are a number of internal and external parties that need to be involved in the process. The important thing is ensuring communication between the different teams, the different departments, and getting the holistic overview of where everything sits.
No one department can be responsible for this alone. There are a number of internal and external parties that need to be involved in the process. The important thing is ensuring communication between the different teams, the different departments, and getting the holistic overview of where everything sits.
Collateral management operations: evaluating the options
The buy/build/outsource debate has been topical for many years. However, with the new regulations now taking effect, many institutions, particularly buy-side firms, have to evaluate the benefits and costs of each of these options. The challenge is to satisfy regulatory requirements while retaining control, in order to generate revenue—often by optimising the available assets, and taking into account funding costs and eligibility criteria.
Often firms, large or small, are still siloed in margining processes, and this can cause added complexity. However, there has been increased interest in cross-asset, “business line” capabilities. This is particularly the case where interoperability with external providers is supported seamlessly via standard APIs, enabling a wider level of automation and STP—and that is not just for the larger organisations. Firms cannot do this alone. It’s about creating an ecosystem that everybody can tap into on a selective view in terms of taking the paths that they require—and also having access to others, should they need them at a later stage.
Very few organisations—with the exception of one or two of the larger sell-side firms—are building in-house. The infrastructure and resource costs and maintaining pace with regulatory and market change, now often outweigh the benefits of those bespoke systems, and although the organisations still need to be able to have some flexibility in how they deal with their internal processes strategy, that comes as an add-on to the standardisation of the vanilla processes. For many, the choice is a vendor solution or to outsource, as opposed to that internal build.
Drivers for vendor solutions include the standardisation of information exchange with counterparties, and coordination of daily operations. Quite often, the number of interfaces and departments that particular organisations may have impact the overall complexity, which can often be addressed by using some sort of cross-asset platform creating a holistic view.
A number of firms are reviewing the cost of both options. Agreement volumes are up—where firms used to have perhaps one legal agreement, often now have three. There are definitely benefits to outsourcing, particularly where there’s a lack of experience within the internal team.
There is no standard approach, and ultimately the decision of whether to build, buy or outsource hinges on the level of control the firm wishes to maintain. The benefits gained from operational activities, such as optimisation, can have a positive effect on the overall cost structure, particularly if that organisation has access to a global inventory, and is able to monitor what collateral is held, where, and how it can be effectively utilised across jurisdictions.
By leveraging a common global infrastructure, firms may be able to reduce operational costs, including the first cost of ownership, and benefit from increased transparency. It’s really about looking to what you’re trying to achieve internally, and what the options are from the firm’s global ecosystem.
