Collateral management is shifting, shaking up business models and relationships. Next to regulation, the foundation underpinning that change is data, and collateral managers want their data platforms to be as solidly built as possible. That’s no simple task, according to panelists at a recent London conference, Holistic approaches to collateral management in the new regulatory environment.
“To optimize something, you need to know where you stand at the moment,” said a panellist in charge of collateral at a large bank based in Germany. “If you have the data in one place, you can build on that – optimize your risk, exposures, liquidity risk, credit risk, do stress scenarios on collateral shortfalls.”
Then, the resulting analysis is fundamental when making a decision on “what’s economically the value of an optimum process”, in which the panellist included the often controversial aspect of transfer pricing, or allocating costs of collateral across desks depending on activities. One of the reasons it’s so controversial is the level of transparency this provides into the business. “What deals are behind generating the collateral you need to post? Who is responsible? Once you have that evidence of the information you need, there is no hiding any more.”
In turn, that transparency is why rhetoric associated with ‘breaking down silos’ and ‘enterprise-wide approaches’ has become conventional wisdom as the way forward. Regulatory, combined with business pressures are pushing the need to “make the best use of one’s inventory across the entire firm to satisfy all collateral requirements,” said a legal expert from a specialist consulting firm. One of the biggest challenges facing firms in doing this is organizing legal data across all relevant documents. When surveyed, most firms, he noted, were open about significant investment being planned and made, with 80% of firms saying that they were planning on spending significant amounts specifically on their legal data.
There’s definitely been some progress: “We have seen digitization of portfolios – making sure that the documents are searchable in order to find certain toxic or problematic clauses that had historically gone into their contracts. We’ve seen use of natural language processing and data extract tools in order to help the process.” But many firms are woefully behind in getting things done, the legal expert added, and a lot of institutions’ documentation storage is a mess. For example, more than a few companies could not answer the question: ‘how many active arrangements do you even have?’ That’s a serious problem not just because of what it says about the firm’s own position, but also in being able to continue doing business under new regulations. Think: margin reform rules coming into effect September this year.
Based on a mandate from the G20, BCBS and IOSCO have developed a framework establishing global minimum standards for margin requirements for non-centrally cleared derivatives. Compliance is staggered, with the first wave being Groups with aggregate notional amount of non-cleared derivatives exceeding $3 trillion. These firms will be required to have initial and variation margin documentation in place. Protocols, he added, will not “save the day” because the application of such tools does not capture all of the optionality in margin provisions in one sweep. At the very least, the one thing all firms can do is understand “who owns responsibility for the different documents within the stack”, he said.
The regulation has enormous implications for how firms will trade in the future, and the way that will shape collateral management. One collateral management expert said that as a result, firms are “rationalizing entity models” and asking: are they fit for purpose? The industry, particularly the buy side, is generally on wait-and-see mode, said a number of speakers.
But for firms coping with meeting those and other regulations now, there’s no such luxury and a lot of walls to tear down. “For a big organization, you probably have more silos than you have elsewhere, given that traditionally a lot of the collateral activities were linked to profit centres alone,” said a collateral manager from a major global bank head-quartered in Europe. And involving profitable business areas means a fight on your hands because it’s going to change the way the economics look, he said. After some five years focused on collateral, he noted, the “80%/20% rule comes into play again and again” in this respect.
Still, it’s not the death knell for fragmented data either. “The silos are there for a reason because you have product specialists on the business side, but at the same time we have new requirements which come from the regulatory side,” he said. One of the important questions to ask was whether or not organization change is just about regulatory reporting, however. “Everybody says that they are changing and think that they are getting there – but where is it actually they are getting to, is it economically driven or is it reporting driven?”
