Let automation take the strain out of collateral management

It is important to put these changes into context. To secure their OTC derivative exposures, buy-side firms have been providing collateral to the sell side for years. But now - for the first time - they are also receiving collateral. While this reduces credit risks, it creates a range of operational risks if not done properly.

A further change in the historic collateral system is that UMR now requires an independent third party to protect the collateral. This was traditionally done by the sell side, which undertook these actions including providing all the valuations. This is why asset managers and other buy-side firms are increasingly looking for automation and why they are looking for custodians and third-party agents to secure the collateral they receive.

Collateral automation is therefore becoming increasingly important and is increasingly common across different businesses such as uncleared margining requirements, repo, and securities lending as it allows the optimised usage of collateral for these different products.

Collateral automation is the first step to optimising collateral management as it reduces the risks of human error. Once the two parties to a trade have signed their respective legal agreements, the lifecycle of collateral management contains a series of operational tasks. These include trade data capture and validation, margin calculation, margin call workflow, collateral booking and optimisation, settlement, reporting, and collateral inventory management.

All these separate elements can now be automated, reducing risks and reducing the costs associated with the risk of errors around issues such as the complexity of recalls, downgrades, corporate events, or taxable events.

A rich ecosystem has emerged of service providers who can automate some or all these services.

The largest players in the market, both buy side and sell side, use triparty collateral management services provided by entities such as Euroclear. In addition, these triparty providers can then connect to other service providers that offer services such as allocation verification, and optimisation, enabling them to offer the full suite of automation to their clients.

Moreover Euroclear facilitates automation beyond pure triparty collateral management. For example, we offer an Open Inventory Sourcing service that automates the management of inventory between a domestic market and Euroclear Bank - allowing the securities to be used onward in triparty. This reduces the fragmentation of the collateral that is detained in domestic markets.

For something as increasingly complex as collateral management, automation makes sense. And to fully reap the benefits of automation, using the services of a triparty service provider will help.

As the name suggests, this involves having a third entity standing between the two parties to a transaction to effect the settlement, clearing and collateral aspects of a trade. Without triparty it is very challenging to process the thousands of lines of collateral, the margin calls, and the corporate event notifications that are part of the wider post-trade process flow.

The scope of the Unclear Margin Regulations (UMR) now covers a wide range of financial institutions including large and smaller buy-side entities.

The latter have come in scope recently with the implementation of the last wave of the regulation and are now for the first time facing the same requirement to exchange collateral as the larger players in the market. They are also finding that collateral is now an important consideration when running their trading and investment and securities lending activities.

Collateral is scarce and the use of it needs to be optimised, and for that to happen, the process flow needs to be automated.

Even so, the benefits of automation are wide. Automation allows different post-trade segments to be connected and for clients to operate effectively in a multi-segment environment.

The Euroclear Collateral Highway delivers automation, Straight-Through Processing (STP) and efficiency in the collateral post-trade area through a suite of inventory management, collateral management, data, and optimisation services ​to international market participants​ across any collateralised business and exposure.

These include securities-financing transactions such as repo and securities lending, OTC derivatives, pledge, GC Access, and central bank liquidity services. Further it is connected to many external market infrastructures and custodians

Collateral automation also provides more widespread benefits, beyond what it does for the collateral operations of individual firms. In particular, it enables both operational-risk and market-risk mitigation for the market as a whole.

Smaller buy-side firms have not traditionally been clients of the triparty collateral management ecosystem for several reasons, but primarily because their sell-side counterparts were taking care of it for them.

But this is changing, and the main hurdle now is connecting to a Triparty Agent, which is also, in most cases, the custodian of the collateral in addition to being a Triparty Agent.

Does the volume of work justify getting signed up and connected to a large new service provider?

Increasingly, there are new options and flexibilities that allow smaller buy-side firms to get some of, it not all, the benefits of triparty collateral automation while continuing to benefit from their existing relationship with their custodian.

For instance, smaller firms can work with Euroclear through pledgee representatives where they go through an intermediary that is already a client of Euroclear. In this way, the smaller entities glean the benefits of automation without the need to become a direct client of Euroclear.

Further, Euroclear’s Collateral Portfolio File service allows buy-side firms to apply triparty functionalities in the books and records of their preferred custodian. This allows them to remain clients of these custodians without going to Euroclear Bank, but while still benefiting from triparty-like functionalities.

Euroclear is also delivering STP and light-touch end-to-end services to other parts of the post-trade world. These allow clients to benefit from more optionality and control over the end-to-end collateral management process​. This includes the Bilateral Repo service for clients active in the bilateral collateral market that are ​seeking to combine the benefits of automation with the flexibility of collateral locations. This allows them to maintain their existing custody and settlement setup with their preferred custodians or market infrastructure.

Automation makes collateral management easier for individual buy-side firms to meet their new regulatory obligations on collateral.

New regulations are pushing the market to make more use of collateral; automation is allowing this to happen with ever greater ease. Moreover, there are flexible ways of taking part that make it cost effective for smaller firms.

Automation takes the strain out of collateral management.