The Basel III liquidity coverage ratio, initial margin segregation for OTC derivatives reform and mandatory clearing are just some of the factors driving demand for collateral management in Asia Pacific. As a consequence, firms have to look at their liquidity profiles and some may need to leverage repo/financing markets to raise cash or obtain eligible assets to cover margin. In turn, these financing trades would typically require margining, compounding pressure on the same operational resources. This is not a region-specific issue – Asia Pacific regulators are typically looking to stay in line with global standards.
“Firms now transfer the cost of collateral via credit valuation and funding valuation adjustments, which has led to increased scrutiny of these costs,” says Nasser Khodri, group managing director Asia Pacific institutional & wholesale at FIS. “To bring down these costs, they require sophisticated collateral optimisation systems.”
Nicolas Faust, collateral and valuation services product specialist for Asia Pacific at BNP Paribas, stresses the importance of efficient and scalable platforms, processes and services that can handle higher volumes triggered by systematic margining.
Many local banks are busy deploying collateral optimisation systems in order to centralise and price collateral and at the same time equip themselves with support capability for tri-party repos and allowing third-party agents to provide initial margin segregation support, observes Davin Cheung, Clearstream’s regional manager for North Asia, global securities financing.
“I think this trend will continue for years to come and will affect firm-wide capital and liquidity management, CCP and OTC margining and matching sell side-and buy-side needs depending on whether the entity is a bank, broker-dealer or buy-side asset management or insurance firm,” he says.
Khodri identifies Singapore, Hong Kong, Australia and Japan as the most dynamic markets in the region. “Singapore has been in the lead so far in terms of next generation collateral solutions, while Japan has been working to adapt its older back-office technology and Australia cannot decide where collateral fits into its business model. Collateral optimisation systems have been scarcely adopted in Asia, so there is certainly plenty of scope for increased adoption over the next few years.”
Northern Trust’s head of derivatives & collateral management EMEA, John Southgate, says that collateral optimisation is rapidly becoming a core component of any collateral management service, although the emergence of new solutions does not mask the fact that this is still a relatively immature service.
Many regulations have not yet taken effect in Asia Pacific, which means the true economic impact of new collateral management requirements has not been felt, adds Stephen Bruel, global head of the derivatives and collateral management product groups for BBH.
“This will change over time as more regulations take effect and the cost of collateral will certainly increase as a result,” he says. “For example, inefficient use of collateral will start to impact portfolio performance and that will drive an increase in optimisation. Many firms won’t have a choice – it will be vital to use an optimisation tool to efficiently allocate collateral, as will optimising internal operations to ensure effective management of middle and back office implications.”
At this stage priority is generally given to repapering and, with an even greater focus, settling variation margin calls in cash, adds Faust. “Only once this initial phase is implemented will there be interest in optimisation by using securities. We also see large asset owners centralising collateral management, including assets managed by third-party investment managers, in order to use asset classes that provide eligible collateral and leave the other asset classes fully invested.”
Rather than concentrating on differences between national markets, Faust identifies different motivations for different client segments. For example, insurance companies of large banking groups may not be equipped with the required level of automation and face regulatory limitations in being able to leverage their group’s capability, for example with regards to initial margin.
“The situation is similar for smaller banks, while large asset managers with significant OTC volumes – in additional to scalable processes – are usually keen to free up their front office resources for their core purpose of investment decision-making,” he continues. “Smaller investment managers do not always have the expertise and resources to face the implementation of such a complex process alone.”
In addition to a straightforward cost-benefit analysis, firms need to understand the changes still to come and decide if they are able to develop a roadmap that allows them to stay ahead.
Bruel suggests the collateral industry is ripe for more significant changes that will require technology investments and maintenance, operating model redesigns, improved data governance and increased interaction between the front and middle offices. “Most asset managers see portfolio management, not the increasingly complex discipline of collateral management, as their core competency and expertise.”
The strength of Hong Kong in this area may seem counterintuitive given its financial history of relying on equity products versus fixed income derivatives, but the growth of offshore RMB deposits has driven swaps trading along with FX, lending and borrowing and structured products, says Finadium managing principal, Josh Galper.
In a recent survey Finadium conducted with 13 major regional banks, it found that 62% had a collateral optimisation platform in place, 23% were working on one and 15% had no plans. “The first group included the international banks with a strong presence in the region – no local bank had a platform or was ready to launch one,” says Galper. “Regional Asian banks tend to partner with technology vendors in collateral as a preferred alternative to building their own platforms, which means that technology vendors should be primed for expansion.”
The Finadium survey also asked banks about the collateral types they preferred to accept, including bonds by government issuers. “Every respondent accepted government bonds by their country of residence and most were willing to accept Japanese and Australian government bonds as well,” says Galper. “Banks were quick to point out the hypothetical nature of some of this acceptance, however – neither they nor their clients were asking to post or accept anything other than bonds of the national government or government-sponsored agencies.”
In terms of trends for acceptable collateral, Cheung says there is an increasing acceptance of equity indices and names, albeit with a higher haircut than for government bonds. Khodri notes that participants are slowly moving towards delivering securities instead of cash to improve their Basel III ratios.
Bruel observes that although regulations allow for a relatively wide range of collateral, cash is still king in Asia. Firms that don’t hold enough cash, perhaps because they don’t want to hold a cash buffer, will want to use securities. However, as new credit support annexes are negotiated they may find counterparties won’t accept collateralisation with securities.
Increasing levels of regulation-induced collateralisation is leading to the standardisation of the types of collateral to cover margin. “What we are seeing as a result of the uncleared margin rules is the sell side further tightening the types of assets they are willing to accept and even pushing for only cash to be accepted, which is compounding the liquidity pressures clients are facing,” adds Southgate.
One of the decisions facing firms in Asia Pacific is whether to handle collateral management internally or to outsource. According to Khodri, the size of the business in terms of the number of collateral agreements seems to be the most influential factor in this decision.
“The primary problem with outsourcing is that the providers of this service are large banks and servicing of smaller customers is not their strength,” he adds. “In a market stress situation people will ask whether their provider will even pick up the phone. By insourcing you remove the wall between your business and the technology required to service your needs.”
New demands on collateral are driving the trend to outsource, according to Southgate, who says firms of all sizes are looking to outsource to a scalable, robust solution. As well as requiring skilled staff to manage collateral, the infrastructure requirements are also driving significant costs for firms looking to support this function in-house.
Northern Trust’s Southgate notes that tri-party agents, typically via a custodian, offer the buy side access to new pools of liquidity, such as corporates looking to put cash to work for returns higher than bank deposit rates.
“The tri-party structure supports greater efficiency and security of assets, as collateral is moved around within that agent’s environment, as opposed to market settlements taking place,” adds Southgate. “Some of the benefits here are favourable cut-off times, simplified collateral substitutions and greater transparency around collateral utilisation. We are working with a number of tri-party agents to ensure we can offer our clients access alongside their bilateral margin processes.”
Cheung notes that tri-party agents offer holistic solutions for both liquidity and collateral management functions, including collateral eligibility checks and allocations, marking-tomarket and auto-margin calls, collateral substitutions and counterparty introductions. “In our case we even provide simplified master tri-party repo documentation that clients sign once for all counterparties, thereby relieving them of the need to negotiate global master repurchase agreements bilaterally.”
Yet, according to Khodri, these agents are expanding into other services and reducing their focus on this service offering as it is not a profit driver. “There is demand but supply is too concentrated,” he suggests.
To comply with the regulations that have come into effect over the last few years, firms will need to support higher volumes of agreements and regulatory reports, additional business processes, shorter settlement cycles as well as sourcing more collateral assets and adopting new market standards. Fortunately, technology solutions are available to help them meet these requirements.
Technology is absolutely instrumental, says Faust. “Collateral management platforms need to be able to handle complexity, complete the process within a short timeframe and have the interconnectivity with other platforms to offer scalability.”
He notes that complexity stems from the large scope of OTC instruments and the management of dual credit support annexes (CSAs), among other factors, and the timeframe is tight given the need for transaction capture, valuation, calculation of exposure and margins as per the CSAs.
According to Bruel, the only way to minimise the impact of new regulations is to maximise the use of technology. “For example, given the expected increase in collateral call volumes, firms need to embed automation throughout the collateral lifecycle,” he concludes. “Methodologies to optimise collateral also require technology – not only related to selection algorithms, but also for data management, reporting and substitution management.”