Firms that fail to address a range of 'fundamental' strategic questions around changing collateral management requirements will find themselves at a disadvantage when it comes to supporting their future funding and investment needs, according to a new white paper co-authored by BNY Mellon, a global leader in investment management and investment services, and London-based consultancy The Field Effect.
The reformation and restructuring of the financial markets in the aftermath of the global financial crisis has had a profound effect on how collateral is used and managed. These ongoing changes to collateral supply and demand dynamics are challenging even the most sophisticated and experienced organisations, with many firms (both financial intermediaries and asset owners) struggling to grasp the full implications and potential opportunities of the new landscape.
The new paper – Collateral Management: A Review of Market Issues– argues that consolidation is "a highly likely outcome" and collateral management will evolve from being primarily a process of managing assets for margin purposes, to a position where much greater consideration is required to manage assets from a collateral value, cost and balance sheet perspective.
The paper examines a number of themes, among them the possibility of a shortfall of market collateral; potential changes firms can make to existing account structures, systems and services; the role of third party service providers in helping market participants to manage collateral effectively; and the future shape of collateral management.
Given the current fragmented collateral landscape, key challenges identified by the paper include:
Compliance with new regulations governing cleared and non-cleared over-the-counter (OTC) derivatives;
For the buy-side, choosing partners who can support complex requirements for margining and collateral mobilisation;
For banks, meeting complex interlocking collateral and capital regulations, whilst offering customers collateral services at a viable price point;
The ability of custodians to provide customers with a cost-effective collateral management service with integrated tri-party capability.
Mark Higgins, managing director, Markets Group at BNY Mellon, and one of the co-authors of the white paper, said: "The development of an effective collateral management solution is a complex combination of market variables, many of which continue to evolve. We believe those firms who fail to master the fundamental strategic collateral questions will find themselves at a considerable disadvantage. Banks may find themselves unable to fund core business lines or meet the needs of clients cost effectively, while asset owners and managers may find themselves unable to pursue preferred investment strategies. Whilst there is consensus that the subject area is complex and in flux, it is also clear that considerable prizes are available for those who identify their specific collateral service elements and requirements."
"Asset managers, pension funds, insurance companies, banks and broker-dealers face complex regulatory and market structure changes," said David Field, founder and principal at The Field Effect. "This task should not be underestimated and many firms may not fully appreciate the challenges they face, nor recognise the opportunities available in the market. As the sophistication of collateral services evolves, we will see increasing levels of innovation from service providers who truly understand their clients' needs and have the vision to develop services to support them. A critical part of the collateral challenge will be for firms to select the service elements they require and identify the service provider that can most effectively meet their needs in the long term."