Is the market moving towards collateral management utilities? (Premium Content)

Between Sapient’s recent survey and the Clearstream Global Securities Finance Summit in Luxembourg, we’ve been hearing a lot lately about the idea of collateral management and clearing utilities. It seems that market actors are gearing themselves up to create self-managed utilities not unlike EquiLend, member-owned clearinghouses or other services that financial institutions own for their mutual benefit. But is this really happening and is it the right time?

What we heard at the Clearstream Summit is heresay and under NDA, so not much can or should be revealed. The common (and public) themes are that groups of banks have been looking at various collateral management utility options including building or replacing their current IT systems, building an industry “best-of-breed” solution, and potentially replacing existing privately owned services like TriOptima and AcadiaSoft. We also heard about banks considering creating a central collateral exchange, which we still think is a pretty interesting topic (for more on that, see “The Central Collateral Funding Desk: A Business Plan,” from October 2014).

The Sapient Global Markets survey, “Overcoming the Cost and Complexity of Central Clearing Mandates” (free registration required) from January 2015, found support for clearing utilities in general and openness to the idea of collateral utilities: “Buy-side firms notably appear keen on designating non-core business operations to industry-wide utilities. In the Sapient survey, 75% of buy-side firms indicated a potential positive interest in utilities. Of the 75%, 10% said they were very interested and 45% said they were interested but need to more fully understand the offering.”

A utility is a catch-phrase to suggest a service performed by an entity that has no profit motive of its own and is open to any market participant. It basically takes a for-profit service currently conducted by a business and seeks to capture that activity in a less-costly format, or at least a format that lets the owners charge the same amount and take back excess profits. Its a good deal for whoever creates the utility and may or may not be a good deal for non-owner users.

The first question here is whether collateral management is a ripe market for industry utilities. The answer is that they already exist: industry-owned CCPs and Central Securities Depositories compete alongside for-profit entities on price and service quality. This is old news. The jockeying we see in collateral management is who actually does what and how, and who earns any excess profit on the deal; this is a critical theme in today’s market and will be discussed at Finadium’s March 19th Conference in NYC.

Looking at for-profit “utilities,” these can include LCH.Clearnet, Clearstream, BNY Mellon, AcadiaSoft, even Broadridge and SunGard, Calypso, Murex and other major backbone providers of securities processing. We just use another name for these firms: we call them businesses.

The second question
is whether industry participants, driven by large banks, think that the current IT service providers do a good job or not at a reasonable price point. This is subject to debate but is typically the argument for why a utility is needed. Industry participants think they can do a better job at a lower cost, or at least sell a new service for the same cost from an ownership position. This is better than just buying a service and letting someone else benefit from the incremental revenues.

Our last question is if collateral management is ready for industry participants to create their own shared ownership structures to compete with private firms. Financial markets have seen successes and failures in this regard. EquiLend has thrived, but in post-trades allocation, the industry-led Global Straight-through Processing Association (GSTPA) fell before the combined powers of Thomson Financial and DTCC, who created Omgeo. Omgeo is now the clear and outstanding market leader in post-trades allocation.

Private providers of collateral management services are no dummies; they see the competitive pressures as well as anyone. Two weeks ago Calypso launched a service to support BCBS/IOSCO requirements for margin on non-cleared derivatives. From their press release, “The new solution will be available to existing Calypso customers as an additional module, and firms that are not Calypso customers will be able to access a cloud-based Utility Service.”

To answer the last question, it is fair to say that enough users need enough services that the game is on for collateral management utilities. This may or may not be the best time, but we expect to see continued movement in this direction through 2015.

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