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Collateral Management Unlocking the Potential in Collateral

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Collateral Management Unlocking the Potential in Collateral Capital Markets | Point of View Collateral Management Unlocking the Potential in Collateral Executive Summary The global collateral management market is worth in excess of €10 trillion. There are, however, numerous inefficiencies reflecting operational difficulties and market constraints which undermine the banking sector’s ability to optimise the value and use of collateral. We estimate that internal fragmentation A reduction in the number of custodian Regulatory developments and market (i.e. inefficiencies specific to individual and settlement agents would reduce the infrastructure developments continue banking institutions) of the global number of liquidity pools, but there is a to drive demand for optimisation of collateral management market costs desire to maintain a range of providers collateral, balance sheet quality, capital more than €4 billion annually. to maintain flexibility over liquidity and liquidity adequacy and improved risk/ availability and avoid high concentration return performance metrics for credit External costs and potential savings are and systemic risk. institutions. The recent requirements more difficult to estimate given that they for clearing OTC derivatives via clearing are dependent upon future regulation, An effective collateral management houses will increase the amount of but our survey suggested that cost framework requires: collateral used and put additional savings could well be considerable. • The ability to aggregate collateral pressure on its management. data by asset classes, locations The highest potential cost savings can encumbrance, currency and legal The role of effective collateral be achieved through: entity management in monetising assets has • Reducing the number of collateral • Detailed underlying data sufficient never been more important. Collateral pools/silos to meet business, counterparty and management is crucial for optimising • Implementing comprehensive IT service provider needs the use of and return on both capital solutions to develop a single • Timely systems with effective and liquidity and requires the proactive application, providing a complete connectivity and interoperability with management of all assets. overview of collateral across all asset service providers to move collateral classes, business divisions and legal efficiently entities • Adopting optimisation algorithms (covering liquidity, capital and regulatory implications) • Improving internal transfer pricing mechanisms 3 The Market Today Collateral is one of the building blocks on which the financial markets are constructed. It is at the core of secured financing and is a key enabler for a multitude of services and products including traditional securities financing, facilitating trading and innovative solutions which allow for risk mitigation. Collateral management can be the catalyst for new business models that can generate significant incremental revenues. Collateral is used for different purposes: To place this in context, the 2010 There are numerous and significant • OTC derivatives margining estimated gross domestic product of inefficiencies in the collateral • Secured funding with market the USA was approximately €10 trillion. management market, both internal counterparties and central banks The total size of the collateral market (bank-specific, related to the business • Trading with central counterparties is thus impressive and representative operating model and organisational (CCPs) of the importance of collateral, however structure employed) and external (the • Settlement collateral remains a small fraction of multiplicity of external services providers the total assets of the global banking that institutions use). Because of these The methodology used to prepare this system, which are estimated to be inefficiencies, collateral management Point of View on collateral management worth €70 trillion. This suggests there has historically been difficult to optimise. was twofold: is further potential for growth in Before the financial crisis, these • Research existing public information monetising unused assets through inefficiencies were considered as on collateral from official and well- improved collateral management. important but not key. known sources • Conduct one-to-one interviews with 16 global banking institutions Figure 1: Market sizing in trillion Euro representing a rich variety of collateral Central-banks-secured funding (44%) management models Settlement (2%) 4.450 320 The total value of securities being OTC derivatives margining (2%) used as collateral in the financial system worldwide is estimated to be 185 Market-secured funding (50%) approximately €10.215 trillion Trading with CCPs (3%) (excluding cash). The total amount 205 5.055 including cash is believed to be well in excess of €12 trillion. 4 The market had traditionally been flooded In Europe alone, it was estimated that As a result, collateral management is with liquidity. Financial institutions banks had an aggregate shortfall of stable increasingly regarded as a core function, viewed collateral management as a funding of €2.89 trillion¹ in order to fully integrated in the management of reactive function positioned at the end comply fully with the additional liquidity financial institutions and closely linked of the trading cycle, performed within requirements of Basel III. to treasury, trading, risk management, a back office function restricted to the operations, finance and capital processing of collateral movements and Credit institutions are presented with management. negotiation of related legal agreements. a number of alternatives, including collateralisation which is becoming Accenture and Clearstream have The recent financial crisis, with its origins crucial in maximising the potential conducted a survey to ascertain how in a severe liquidity crunch, dramatically benefits that can be generated from all market practitioners view collateral changed the perception and importance internal resources available to a credit management. We interviewed 16 of collateral management. As a result institution. There are multiple benefits institutions representing €14 trillion of the crisis, the objectives of regulators that accrue from collateralisation both in assets. Their views form the basis of and market participants have become for collateral takers and providers: this report’s findings and their opinions remarkably aligned. Whilst regulators are were clear: in an era of reduced revenues looking to enhance prudential supervision Collateral takers: within banking generally, reducing costs by addressing more rigorous capital and • Reduction of capital utilisation by was clearly crucial. To that end, reducing liquidity adequacy standards, credit reducing credit and counterparty risk internal and external fragmentation institutions are looking to improve the exposures related to collateral management has quality of their asset base both to reduce therefore become a critical concern: credit and counterparty risk and to Collateral providers: 38% of our survey’s interviewees have improve their liquidity profile. • Increase in secured financing managed to reduce internal inefficiency opportunities (and lower cost of costs during the past three years, funding) while 25% have reduced external 1 Quantitative Impact Study of Basel Committee • Generation of additional revenues inefficiency costs. on Banking Supervision (December 2010). from the reutilisation of assets. 5 Multiple Approaches to Collateral Management The 16 global institutions interviewed in our survey represented a rich variety of approaches to collateral management which were influenced by their overall business model, their geographical dispersion and their internal governance and legal structure. Figure 2: Approaches to collateral management Business model Internal Approaches to Collateral Geographic governance Management footprint Internal organisation The criteria for assessing the effectiveness businesses and the operating model encumbered has been recognised as a of the collateral management models are employed have a significant bearing basic requirement that has been fulfilled summarised as follows: on the way collateral management is since the 1990s. However, the creation • The ability to identify at any point in addressed. of a single view as opposed to fragmented time what assets exist (across all views on a single collateral management businesses, legal entities, currencies, In total, the 16 institutions interviewed platform in which sophisticated products/asset classes, locations) held assets of approximately €14 trillion, optimisation processes are supported by • The ability to determine if assets are representing close to 20% of the total centralised management has required available or encumbered and the assets of the global banking system². extensive and prolonged investment in degree to which substitution is The sample captured combinations of systems development and infrastructure available/possible the following businesses and operating build. In at least one case the process • The ability to use all assets irrespective models. has taken in excess of ten years. of “internal” ownership • The ability to price assets reflecting Retail and wholesale banks have liquidity, capital impact, strategic value Business model traditionally had ample liquidity as a to the organisation and regulatory result of the large and relatively secure implications Investment banks and broker dealers deposit base accessible through their • The ability to mobilise
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