Collateral Challenge
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.”
Centralising
collateral
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.
Outsourcing
dilemma
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.
Technological
demands
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.”
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