The network effect of collateral management

As we have already witnessed, 2017 has and will continue to bring fundamental changes to regulations, challenging even the most robust operational teams across the industry who are asked to do more with less, on ever shorter deadlines. We look at the impact of collateral management within these functions that are pushed to their limits, …

by | May 30, 2017 | CloudMargin

As we have already witnessed, 2017 has and will continue to bring fundamental changes to regulations, challenging even the most robust operational teams across the industry who are asked to do more with less, on ever shorter deadlines. We look at the impact of collateral management within these functions that are pushed to their limits, and how shifts in technological approaches may help treasurers address these issues.

Collateral management has been a hot topic ever since the start of the financial crisis in 2008, but in reality this was only a talking point for those of us in the industry. Issues such as collateral shortage fears, collateral optimisation, automation of collateral calls and payments were discussed at many a conference, but very little actually changed.

Everything has changed in 2017

The implementation of new regulation will fundamentally alter the collateral landscape. Most recently, we have seen the execution of the variation margin ‘Big bang’ rules for non-cleared derivatives, which came into force as of March 1st 2017.  Some corporates, those directly captured by the rules, will still be working hard to remain compliant, nearly three months after the deadline.

For those captured, the new rules will greatly increase the frequency of margin calls, as daily margin movements are required. Estimates vary, but increases in activity of around 500% are generally accepted as being broadly accurate. This increase is being mainly attributed to the inclusion of FX transactions in the margining obligations.

It still rings true that the biggest pain points here are about the daily operational issues sure to come and the continued spread of collateral management out from the back office through to the front office.

Firms are just barely discussing how their collateral management programmes will adjust in terms of processes, technology and implementation among other factors. Many firms looking to address the operational challenges with technology are dealing with extremely tight timelines, and as we know, most traditional software still goes through a half a year or more to implement along with a drain on internal resources – something firms do not have an excess of right now.

What is clear is that collateral management has become a dynamic part of business. Traders benefit from knowing collateral requirements BEFORE they enter into a trade and this data is only becoming more and more available due to operational efficiencies achieved through state of the art technology.

The changing tide of collateral management

In addition, collateral management will become more connected through the adoption of electronic messaging. This is a much-needed evolution from the email/phone call approach ubiquitous today. Automation allows users to click a button and watch as their collateral calls are sent, accepted and paid. In fact, why move collateral around at all? Demand for tri-party custody services will increase as a more efficient way of paying or receiving margin collateral.

The rise of the central counterparties (CCPs) will continue. Increased adoption of central clearing will occur and all major CCPs will look to bring their trade-processing capability to the non-centrally cleared market (i.e. they process trades by calculating margin in much the same way they do now, but the trade still legally faces the original counterparty).

In short, therefore, 2017 brings more activity, more automation and more fragmentation. The conventional wisdom would, of course, therefore be a correlated increase in the overall expense of managing collateral. Where one person’s cost is another person’s revenue, there will also be several institutions willing to take your hard-earned money in return for the latest ‘whizz-bang’ solution that looks strangely like last year’s… which never really took off!

You no longer have to do more with less

We strongly believe 2017 will change more than just regulation, however. The challenges corporates are now experiencing in this new era cannot be solved by deploying the same type of technology of years past that carry enormous expense, incredibly long implementation timelines and the resource drain of regular upgrades and maintenance. That is why we’re seeing ‘cloud’ technologies (also called Software as a Service – or SaaS) actually delivering meaningful change for businesses.

As firms are seeing costs rise due to uncertainty and complexity, cloud-based technology is the only way to address operational complexities and actually lower costs at the same time. Many corporates already trust cloud technology to deliver increased operational efficiencies in different functions. The most popular example being Salesforce, a powerful cloud-based solution used by sales and marketing teams across every industry. Corporates also use cloud-based technology for project management, accounting and human resources, to name a few.

Specific to collateral management, however, deploying technology through the cloud makes collateral management significantly more efficient by decreasing costs, establishing far quicker implementation timelines and practically eliminating the amount of resources needed to maintain the technology in the first place, allowing firms to redeploy smart employees to more productive initiatives. The rapid migration onto cloud-based technologies is demonstrable through the results of those companies at the vanguard of this movement. Amazon Web Services grew 55% in 2016, and Microsoft has committed to generating $20bn though its corporate cloud business by 2018.

These two institutions and many others are the direct benefactors of this wave of modernisation.

So, what does this mean for you?

With very many corporate treasurers managing collateral on a spreadsheet today, the introduction of cloud technologies means that robust, fully encrypted, automated solutions are now available for only a little more than the subscription to this magazine. Think Netflix versus Blockbuster.

For some, the spreadsheet option will continue to suffice. For others, who are more exercised about market liquidity, data security and/or operational risk, a cloud solution may be the way forward.

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