Buy-side innovation in collateral management continues to be driven by firms’ needs to align with the business, control costs and provide transparency. In an interview with Securities Finance Monitor, Grigorios Papamanousakis, quant strategist at UK-based Aberdeen Asset Management, explains why managing the complexity that comes along with those needs means blockchain and cloud computing are going to be hot tech topics this year.
The collateral environment is already complex, but is becoming even more so from both a regulatory and ‘client profile’ perspective, said Papamanousakis. By client profile, he is referring to the wide range of needs across the industry from investing on an absolute return idea, where derivatives will be used to generate alpha, to insurance clients transacting mainly for hedging purposes as an overlay.
One of the more interesting developments, he added, is how blockchain or distributed ledgers will aid transparency of transactions between counterparties and cost control. “Blockchain will take a more active role in the financial sector and collateral management is an ideal application,” he said. Papamanousakis expects that ultimately, there could be a closed network of participants such as investment banks, asset managers and regulators. Simple derivatives, like interest rate swaps, are the asset class likely first in line.
“The most important reason is the underlying cost,” he said. “All of the big banks spend quite a few billions for costs for the bureaucratic part of the back office. This is a huge cost for all the participants, and the simplification, automation part of that process will be broadly (welcomed).”
It’s early days to identify any winners from the handful of start-up companies making forays into blockchain technology for finance, he said, because first, industry-wide acceptance of the technology will need to happen. But that looks likely as major players like Goldman Sachs, JP Morgan, UBS, other investment banks and asset managers are jumping in to fund early stage start-ups. “Everyone wants to solve this problem because everybody needs the money,” Papamanousakis said.
Another balance sheet trend to watch, which comes along with a need for advanced technology, is the preference for non-cash collateral. In Europe, it’s fairly well accepted in markets, but non-cash collateral is also gaining steam in the ‘cash is king’ US. That trend is highly linked to liquidity issues, said Aberdeen’s Papamanousakis. In a world where balance sheets are squeezed, instead of posting cash directly, it could be optimal to get bonds via repo markets despite the additional haircuts.
But monitoring credit risk of the bonds comes with its own problems, as do the more complex collateral products like credit default swaps or mortgage backed securities. The point is that in terms of the collateral modelling, non-cash means complexity, which increasingly requires new high performance computing technologies. One of the solutions there, said Papamanousakis, is outsourcing computational power using the cloud. More firms are going to spend to have an account with a cloud provider, and have direct access to high speed, high functionality servers able to efficiently make the billions of calculations required for considerably less cost, he noted.
