Ted Allen, vice president, collateral management, at SunGard Financial Systems
Like many a desk-bound, middle-aged professional, I work off my stress through triathlons. One important thing I have learned about training and racing, is that to maximise your performance you need the right diet to complement your hard work. But what is more important – the pre or post workout meal? In collateral optimisation many professionals are faced with the same question. While the benefits of pre-trade optimisation are intuitive, a recent study by SunGard and Sapient Global Markets has demonstrated the proven cost reductions from post-trade collateral optimisation can be impressive too.
Our study found that an improved performance of between 3 to 10 basis points can be expected on a typical bank portfolio of collateral requirements and inventory, after implementing a collateral optimisation programme. Post-trade optimisation results vary according to agreement quality, inventory structure and internal funding costs. A recent proof of value at a large European bank demonstrated improved performance of 7.5 basis points. Previously, we have seen opinion and theory which may be sound, but results from a real life study using a major bank’s inventory have not been publicised before. Such significant potential savings will be of interest to treasurers and those charged with delivering a collateral optimisation programme.
Collateral requirements impact every part of the trade lifecycle and therefore differing optimisation approaches should be deployed at each stage of the cycle. The final set of levers is applied after the trade is made with the key aim of optimising the allocation of collateral assets.
Collateral inventory optimisation allows the firm to post the “cheapest-to-deliver” collateral after considering funding costs and opportunity costs. Collateral optimisation algorithms identify within a single process the collateral that should be posted across a global set of requirements and the collateral that should be kept back.
The benefits of the more advanced collateral optimisation techniques can go beyond minimising costs of collateral usage. The liquidity potential of the available remaining inventory can be maximised as well. This is increasingly important because the Liquidity Coverage Ratio (LCR) and the Net Stable Funding Ratio (NSFR) introduced by the Basel III regulators represent binding constraints on short-term and medium- to long-term liquidity strategies. The ratios force banks to set aside a larger amount of liquid assets or to curtail businesses that consume liquidity. Collateral optimisation on the other hand, can be used to mobilise liquidity and thus allow firms to conduct more business. Until recently, liquidity and balance sheet management have not really been considered as a component of the cheapest-to-deliver paradigm but this will change.
The key is collateral optimisation mobilises liquidity and thus, allows firms to conduct more business. It can offer significant savings, depending on a firm’s portfolio of posted collateral, constellation of counterparties, implemented processes and specific funding spreads. Optimisation techniques provide full cost transparency and can help financial institutions to accurately price derivatives through collateral transfer pricing.
Pre-trade and post-trade optimisation techniques are complementary rather than competing strategies. Optimising a deal on a pre-trade basis through choosing the right product, counterparty and clearing venue works hand in hand with post-trade optimal collateral allocation. Indeed, implementing a range of optimisation techniques offers various synergies and delivers a more holistic approach with enhanced results. With this in mind, you might consider a snack before and after doing your workout.