The Collateral Management Conundrum: Can Regulatory Compliance and Strategic Solutions Co-Exist?
On 20 September 2016, over 200 collateral management market participants gathered in New York for the 2nd Annual Collateral Management Conference for the Americas. The theme of the day revolved around 'The Collateral Management Conundrum: Can Regulatory Compliance and Strategic Solutions Co-Exist?'
Market practitioners from the buy-side, sell-side, custodians, administrators, regulators and policymakers discussed how the industry could work towards achieving compliance without losing sight of the strategic opportunity to optimise collateral mobility and processing.
While the September 2016 regulatory deadline has now passed for the world’s largest dealers, the rest of the industry is still facing the next waves of regulatory compliance. Compliance programmes present challenges in resource prioritisation and internal focus.
If firms can take a long-term view, compliance programmes can also serve as catalysts to search for innovation, implement next-generation collateral management processes and solutions that will position firms well for a harmonised collateral management approach.
Pressure on liquidity
Post-crisis financial regulations have also resulted in a reduction in funding sources, a drain in liquidity, and the dampening of collateral velocity. For example, impact on each sell-side market participant is expected to be significant. A recent report by GlobalCollateral and PwC estimates that each sell-side market participant will need to annually fund more than USD 570 million to post as Initial Margin (IM) against bilateral OTC derivatives exposure.
While it is generally believed that there is enough collateral in the system, the challenge for firms is to effectively access and optimise the use of the available collateral across assets and counterparties, while reducing intra-day liquidity costs and balance sheet impact. Now, more than ever, there is a need for efficient collateral management processes that will help firms optimise the use of their assets from a collateral value, regulatory capital, and balance sheet perspective.
Regulatory change is expected to result in a 5 to 10-fold increase in margin calls, straining already stretched operations teams. This escalation in call volumes will not only result in increased costs, but the heavier operational burden will also potentially impact margin call fail rates.
In the 'Cost of Collateral Settlement Fails' paper we released in March, we estimated that the potential cost of collateral settlement fails could rise 470% to 3.6 million-dollars for each buy-side firm, and 377% to 2.4 million-dollars for each sell-side firm by 2020.
At the current average collateral settlement fail rate of 3%, the annual industry-wide unsupported exposure due to collateral settlement failure for the sell-side is estimated to hit nearly 27 billion-dollars by 2020.
There will therefore be a greater need to monitor and report across currently-fragmented collateral operations to improve visibility, velocity and mobility of collateral across settlement locations.
The need for a market utility
While the first deadline for the largest dealers has passed, the 'big bang' March 2017 milestone for the buy-side and wave 2 dealers is looming. For wave 1 dealers, this also means that the number and complexity of their counterparties will increase.
There is an urgent need for an industry utility that will help firms impacted by the 2017 regulatory implementations:
- Firms in-scope for wave 2 initial margining rules need to achieve regulatory compliance
- Virtually all firms need to create efficiency and transparency to thrive under the upcoming variation margin rules
- Firms that were part of wave 1 initial margin rules who transact with later impacted firms need to increase visibility and control.
DTCC-Euroclear GlobalCollateral Ltd is an industry solution to an industry-wide challenge. We offer the market an easy-to-deploy solution that helps individual firms:
- Achieve compliance with VM, IM & segregation rules
- Manage counterparty, liquidity, operational & regulatory risk
- Achieve cost, capital and operational efficiency
But beyond the deployment of individual firm solutions, GlobalCollateral offers the industry the ability to mutualise costs, while centralising, standardising and optimising post-trade processing for margin & collateral.
The challenges faced by the industry are bigger than an individual firm: the industry is collectively facing ongoing challenges that require industry-wide solutions. While market participants compete with each other on one level, there is also need to collaborate on another.
DTCC-Euroclear GlobalCollateral Ltd is an industry utility that offers an easy route from compliance to a strategic end-state industry model.