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What Collateral Management Means for Your Business

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What Collateral Management Means for Your Business What collateral management means for your business A Regulatory Overview The financial system and the processes that underpin it have adopted nuanced interpretations that have scope to have changed dramatically since the financial crisis. The result in arbitrage when implemented. Whereas markets role of over-the-counter (OTC) instruments in in the EU and US have broadly standardised legislation, exacerbating the crisis forced regulators to act globally. this is not the case in Asia. The majority of OTC derivatives are being forced into central counterparty clearing houses (CCPs) following This could lead to certain Asian markets introducing rules enactment of the Dodd-Frank Act in the US, the that could be perceived as being less onerous than in European Market Infrastructure Regulation (EMIR) and other jurisdictions. Equally, margin calculations and the various requirements in Asia-Pacific (APAC). The requirement to post margin on T+1 is likely to cause systemic nature of CCPs requires its clearing members complications, particularly given the time-zone to post initial margin in the form of cash collateral or differences between Europe and Asia. This could make government bonds, and variation margin in the form of margin payments operationally challenging and it is cash collateral only. Variation margin is correlated to advised that Asia be given two working days to post market volatility, and could be called upon from clearing margin instead. Derivatives usage in Asia relative to members several times per day by the CCP if markets Europe and the US is far lower. But the requirement for are stressed. Asian managers to post initial and variation margin is an issue as many have either been excused from these But what about the OTC products that are not centrally rules, or have at most been required to post margin cleared? Some OTCs will be denied entry into CCPs infrequently. These obligations will take time for Asia- because they are complex or high-risk, and clearing based managers to acclimatise to, and collateral houses cannot afford to jeopardise their business model management is something they ought to consider by clearing esoteric instruments. Regulators have also outsourcing to established providers with a strong local been forthright about the type of instruments that are presence such as HSBC. permitted into centralised clearing. These esoteric OTCs, which may include inflation swaps and swaptions, will At the heart of these rules lies collateral. Fund managers trade bilaterally but counterparties will be obliged to post need to obtain eligible collateral if they are clearing trades more margin. The rules underpinning bilateral OTC or trading OTCs bilaterally. This collateral must be margining have been laid down by the Basel Committee high-quality and sourcing it is going to be challenging. on Banking Supervision (BCBS) and the International Banks and insurers are required to hold high-quality liquid Organisation of Securities Commissions (IOSCO). These assets (HQLA) under Basel III and Solvency II requirements are going to put enormous pressure on respectively meaning there could be limited availability of fund managers and asset owners to source eligible eligible collateral. Repo desks at banks are also under collateral to post at CCPs and for bilateral OTC enormous pressure due to the Basel III capital transactions. requirements and are scaling back on their repo activities. This makes it even harder for fund managers to source The challenge is complicated by regulatory arbitrage. EU collateral. rules require their CCPs to collect initial margin to absorb two days of losses whereas the US requires margin to Some believe a collateral shortfall or squeeze – whereby cover just one day, although the latter calculates margin financial institutions are unable to obtain the prerequisite on a net basis as opposed to gross in Europe. Margin collateral – resulting in a shutdown of OTC trading activity requirements for bilaterally traded OTC instruments are could materialise. This is unlikely. The likelihood of a broadly similar but there are slight nuances in different collateral shortfall has been reduced for several reasons. geographies such as the US, EU and APAC. The The regulators introduced the rules on a step-by-step materiality thresholds for posting margin on bilateral basis and there has not been a ‘big bang’ to speak of. OTCs is different in the US and EU as are the This means the industry has been given time to get their implementation time-frames. This could create processes in place. Furthermore, CCPs have allowed a difficulties for affected financial and non-financial greater scope of instruments – such as certain equities institutions. – to be posted as collateral although haircuts are imposed. This has again given the market flexibility. The problem is particularly acute in Asia. The lack of a pan-Asian regulator results in additional complexity given The State of Readiness at Fund Managers the myriad views and opinions of industry participants Managers have made a number of in-roads around across the region’s main derivatives markets. As such, preparing for the incoming collateral management multiple regulatory authorities in the region have issued requirements under these various regulatory initiatives. consultation papers that are not necessarily harmonised. Generally speaking, US and European managers are in Despite the BCBS IOSCO guidance on bilateral margining tune with market developments and are working with of un-cleared OTC instruments, Asia-based regulators service providers to help them with their collateral management operations. However, in jurisdictions across margin components and automates clients’ margin APAC – such as Hong Kong and Singapore – there obligations through to the relevant clearing venue. These appears to be less awareness of the rules and their collateral movements are processed on a straight-through implications. Fund managers must analyse where and process basis using market standard SWIFT links with from whom they can obtain eligible collateral. A number custodians. Client reporting is provided online via HSBC’s of fund managers will look to banks or other asset client portal and includes underlying trade and collateral owners for collateral transformation upgrade trades. As a position information. first step, fund managers ought to be looking at whether their International Swaps and Derivatives Association It is important that collateral management is largely an (ISDA) and Credit Support Annex agreements with their automated process, and that end clients can continually counterparties need to be rewritten to take into account review their counterparty exposures and collateral of the new collateral management processes. This will positions and keep track of where their assets are be a time-consuming process. located. One of the benefits of outsourcing to a service provider which invests heavily in its technology, Many asset managers are heavily reliant on antiquated processes and people is that it can reduce costs at the systems, which can breed inefficiencies and manual asset manager, but at the same time managers are able errors. Fund managers are at a cross-roads. Many firms to maintain control of their risk and exposures through an are reliant on internal collateral management systems efficient oversight model underpinned by data from the that do not give them a great deal of automation or service provider. Cost savings can be incurred on both a sophistication over their process. In extreme cases technology and a personnel level at the fund manager (particularly in Asia) some firms still use basic data base through outsourcing. tools to calculate their collateral exposures and record movements. Others may not have a holistic view over One of the challenges of building an in-house system to their inventories and portfolios and this can make deal with collateral management is that technology collateral management very challenging and burdensome changes at a very fast pace. The majority of firms will for some. already be assessing their technology systems within a year of actually implementing them. This can be costly An increasing number of fund managers are also and quite disruptive for asset managers’ processes. recognising that collateral management is no longer just a Service providers such as HSBC Securities Services will middle or back office functionality. It is firmly now a core naturally look to future-proof their technology enabling it component of the front office and risk management. to have flexibility to deal with market and technological Firms should be engaging with service providers with changes. HSBC’s objective is to keep on top of regulatory robust technology offerings to assist them with collateral change and help drive through industry best practice in management. These rules are being implemented at a the collateral management space. In addition, HSBC is time when number of regulations are in full train including focused on automation and aligning the services we offer AIFMD, FATCA and UCITS V, for example. As such, fund for bilateral, cleared and listed derivatives so as to have a managers are under enormous pressure. holistic multi product solution to support clients’ current and future collateral and inventory management needs. HSBC’s strategy is to future-proof collateral management Failing to adapt to the collateral services using market leading technology supported by a global service model, and industry leading practitioners management
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