Sharing Collateral Infrastructure: A Best Case Scenario for Users

The collateral management infrastructure market is evolving at a rapid pace, with new ideas emerging on a regular basis for how banks, insurance companies and fund managers can solve some of the most complex challenges in today’s financial markets through effective technology use. A “best case” scenario for using collateral infrastructure that shares “mutualized” technology and applications across the industry is now coming into view. This article explains that best case, and why industry utilities and shared services are the path forward for market practitioners.

Concerning collateral supply, it now appears there is enough high quality collateral holistically to meet new collateralized trading requirements. Because of the specter of potentially needing an additional $2 to $4 trillion of collateral, many firms shed capital-intensive business lines, raised additional capital and began to amass large cash positions. Currently, banks hold US$2.6 trillion above and beyond the top band of their reserve balance requirements with the Federal Reserve. On its face, this sounds like great news in the aggregate, but it is unclear whether individual firms have ample quality assets on hand, or whether they will face collateral bottlenecks.

Since we believe that enough raw collateral is now in the market to satisfy all needs, the next questions are whether that collateral is accessible and at what price. Collateral bottlenecks seem to be real: even if a firm does have enough high quality collateral, do their internal systems and processes provide global access and cross-entity optimization? Aggregate collateral may be appear to be available, however, if it is needed in Spain but rests in Singapore, is it truly accessible? While tri-party agents have been working to create large collateral pools, it is also the responsibility of each firm to know how to access their own internal collateral supply first, and only then reach out to disparate pools for additional collateral resources.

The best-case scenario for solving the collateral bottleneck problem is for each firm to establish a broad network of collateral sources with a single point of access that incorporates advanced inventory management tools. This consolidation of multiple touch points into one “shared service” portal means that internally, the market becomes consolidated and accessible. There is a parallel to aggregating collateral sources in the creation of Central Limit Order Books: both collect large amounts of information to form readily usable action items.

The best way for firms to create this single touch point is by working together, or, through the “mutualization” of intellection property. There are substantial industry precedents for this kind of cooperation. Firms should direct their efforts towards more value-added activities rather than duplicate each other’s internal build work to create basic infrastructure. The resources required for firms to develop individual collateral management infrastructures that are compliant with evolving regulatory and market demands will continue to climb. Any competitive advantage provided by internally creating “one-off” collateral management solutions will be outweighed by the overhead incurred in supporting these activities. Value-added services may mean focusing on ISDA collateral agreements to post the most advantageous collateral and building client relationships, rather than establishing inventory and margin management tools, or linkages to the next collateral repository. These tasks could just as easily be managed by third party vendors. The sharing of collateral infrastructure is a best case scenario for the financial services industry.

– Jerry Friedhoff is Managing Director of Securities Finance and Collateral Management at Broadridge Financial Solutions.

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