The securities lending industry is rightly attentive to important issues like collateral optimization and finding the most cost effective use of limited capital. With attention turned towards these larger macro issues however, it is easy to look past the fact that there are still significant opportunities to reduce capital utilization through more efficient management of collateral exposure.
At the same time, as global markets become more aligned through converging business practices for example the increasing utilization of non-cash collateral in the US, firms are seeking ways to bring multiple geographies together into a common workflow. Pirum remains highly focused on identifying inefficiencies in these areas and providing globally minded solutions that automate exposure reduction processes.
Real Time Exposure Management is Real
Let’s face it: despite enormous strides in the capabilities of technology and reactions to ever tighter constraints on the use of capital, large segments of the market continue to live with exposure management processes that have changed little since the 1980s. A particularly costly example of this is the way firms calculate and mitigate exposure in nearly all types of securities lending, whether the collateral is cash, tri-party or bilateral securities. These processes still largely operate in static time slices, sometimes as infrequently as once a day. Counterparties still pick a fixed schedule to perform and reconcile their calculations, and subsequently instruct settlement of collateral movements. The collateral movements may occur hours after the fact and, by the time they occur, may no longer accurately represent the real state of exposure.
The result has always been that one side or the other is left with residual exposure that must go directly into their capital reserve. The old saying that “time is money” is never more true than when looking at counterparty exposure, and the resulting capital charges.
Beginning with our RQV reconciliation service, and now with our real-time loan release service, Pirum has brought exposure management current to today’s real needs. Pirum’s links into the tri-party services – BNY Mellon, JP Morgan and most recently Euroclear – and to the counterparties engaged in the underlying loans allows our clients to monitor, report and eliminate collateral exposure in near real time. The loan release service is particularly helping to eliminate the capital costs of the one or two-day pre-pay by allowing pre-pay collateral to be confirmed and loans released within as little as minutes.
The same holds true with bilaterally managed collateral. With our ability to monitor collateral receipt versus collateral requirements, Pirum can stage the delivery of the underlying loans as soon as the necessary levels have been achieved.
For firms operating with limited capital, it simply does not make sense to tie it up in non-productive overnight capital charges when the technology and the automation exists to prevent it.
A Global View
Another inherited tradition, operating in geographic silos, is proving as costly for firms as static collateralization. Collateral exposure and mitigation have always been managed along geographical and product lines, despite the fact that overall capital charges resulting from business with any particular counterparty are taken globally across the entire book. This is truly a case where the whole is not the sum of the parts.
Each desk separately computes and takes action against its own counterparty exposure for its own asset class and product. Because of this, firms can find themselves over-collateralized with a counterparty in US equities but under-collateralized in European fixed income. Both desks independently take the appropriate action, instructing collateral movements and adjustments to rectify the situation, with all the resulting transaction costs and operational overhead. Had they been able to look at the overall status of the book with the counterparty, they may have found that the one offset the other, and there may not have been a need to adjust collateral at all.
Pirum clients are able to submit a global book of business across multiple asset classes to our platform, from which we can derive and produce a top-level view of counterparties and collateral. These insights provide our customers with the information they need to make high-level business driven decisions rather than ground-up, process driven decisions. Through this more holistic, single system approach to managing collateral exposure, our customers can gain material savings in settlement and operational costs.
Not all firms are ready for real-time however. Some firms still have extremely manual processes to calculate daily exposure numbers. Often, we are told it can sometimes take anywhere between ten minutes to over an hour just to get an exposure number from systems due to the complex nature of running reports and collating figures manually. In the current market environment where risk, capital and exposure are now a primary focus for the trading desks, Pirum can substantially enhance existing real-time exposure services by providing one dashboard for firm-wide exposures, improving reporting and audit tools, and setting controls and alerts to capture unmapped accounts and exposure swings.
Non-cash Collateral in the US – No Longer an “Emerging Market”
No discussion of collateral exposure management can be complete without addressing the fact that non-cash collateral is now well within the mainstream of securities finance in the US. Market data has shown estimates that as of 2015, non-cash had overtaken cash globally as the preferred collateral in securities lending. This was largely driven by the fact that for the first time roughly a quarter of securities lending in the US was collateralized by something other than cash.
Since 2015, the trend has only increased. The upshot is that while cash remains predominant in US securities lending and other securities finance activities, the US can no longer be called a strictly “cash market.” This fact only exacerbates the pain points discussed above: lack of real-time exposure management and lack of a globally informed view. This is further complicated in the US by several key challenges:
- The industry infrastructure is still largely centered on traditional “DVP/Cash Collateral” settlement.
- Major vendors and utilities are extremely automated when it comes to managing cash collateral exposure, but not nearly so when it comes to non-cash collateral.
- Because US markets have largely been unique in their preference for cash collateral, the technology, business processes and systems were purpose built for the US market.
- Regulation and rules around the permitted use of securities collateral in the US are significantly different than in most other parts of the world. These reflect both more stringent constraints on the use of customer securities than in other jurisdictions; and a regulatory bias for cash as collateral.
US securities finance operations now using non-cash collateral should not seek to trace the process and development path of Europe as it was, but can bypass European problems and achieve highly productive solutions. As US firms break out of their geographical isolation in this respect, their investments should also include the global, holistic view of exposure from the beginning; and nothing should prevent them from gaining maximum capital efficiencies.
Efficient collateral exposure management is an untapped resource for significant cash savings. The move towards efficiency requires some detailed work and technology. We have seen our clients achieve meaningful savings with the appropriate use of technology to streamline collateral exposures. In the new regulatory era, taking advantage of these types of balance sheet savings is the next stage of work at global financial institutions.
Rajen Sheth is CEO of Pirum Systems.