Derivatives collateral management: A long and winding road for the buy-side

Mandatory compliance for Category 1 counterparties – typically global banks and brokers – already had taken place with the clearing obligation as from June 2016. Other clearing obligation deadlines will hit the other categories of firms until August 2019 (Category 4).

For the non-cleared OTC Derivatives, initial margin and variable margin requirements applied in Europe for the high-volume users as of 4 February 2017 – following the US, Canada and Japan who had to comply as of 1 September 2016.

In addition, on 1 March 2017, variable margin requirements started to apply for all counterparties not impacted by the initial February date. However, the rules introduced a staggered schedule for the implementation of initial margin requirements which means that some firms, mainly buy-side, need only to comply by 1 September 2020.

Understandably, buy-side firms are still finding their feet, coordinating their front- and back-office processes, and developing the most cost-effective procedures for accessing and delivering collateral to support both cleared and non-cleared OTC derivatives trades.

As reflected in a panel session on derivatives collateral management at the Euroclear Collateral Conference 2017, this effort also includes closer collaboration with key partners and suppliers, including clearing houses, custodians, brokers and technology vendors.

For many, the end-goal of these changes is a closer alignment of clearing and collateral management across cleared and non-cleared OTC derivatives transactions. To achieve such harmonisation, however, firms are first looking to improve automation and standardisation of their workflows to handle the increased volume and frequency of margin calls.

“Our business model is based on scalability, which means we’re used to automation. From a collateral management perspective, we want solutions that deliver STP, rather than having to hire extra staff.”

According to Bohlke, there is no consensus yet on the treatment of OTC derivatives trades that lie outside the clearing obligation framed by EMIR, meaning that buy-side firms are asked by counterparts whether they wish to clear centrally or not.

The non-cleared route is evidently attractive to firms keen to use their securities inventory for margin purposes, but Bohlke would like to deploy these assets in the cleared space too. As such, he called not only for wider eligibility criteria from clearing houses, but also a shift from transfer of the beneficial ownership of collateral assets to pledge structures.

Tina Hasenpusch, Global Head of Clearing House Operations at CME Group, noted that whereas clearing houses are already accepting a wide range of collateral and are constantly looking to extend their range of eligible collateral, their ability to do so was ultimately limited by the need to only ever hold highly liquid resources.

The guidelines for margin payments between counterparties to non-cleared OTC derivatives permit a wide range of collateral, but clearing houses, unlike banks, typically cannot accept the liquidity risk associated to an equally wide range.

“As a result of the first two waves of firms complying with new margin rules, the industry has had to collaborate at a new level, concentrate on standardising its activities, and focus on automation,” he said.

“In this way, tools like ours let firms communicate with all their margining counterparties, agreeing margin, moving and confirming collateral, in a single place. As the rules start taking effect across a broader swathe of firms, a more automated, standardised and controlled market will emerge.”