Greater automation of collateral management systems to meet changes in OTC derivatives trading from post-crisis regulatory reform will be key for participants’ ability to adapt, according to a report from consultancy Woodbine Associates.
More efficient use of collateral and centralised record keeping through management systems will be key for market participants to successfully adapt to the requirements of central counterparty (CCP) collateral demands for OTC derivatives trading.
The global post-crisis drive to send opaque swaps trades through CCPs means the buy-side has to pledge more high-quality collateral to sustain its swaps activity in line with Dodd-Frank Act and European market infrastructure regulation rules.
To achieve this, straight-through-processing (STP), and centralised record keeping, in addition to real-time functionality across the breadth of a firm’s operations, will be vital to participants’ swaps activity.
“The need for deeper integration between collateral, liquidity and funding should compel firms to manage these areas more closely in day to day operations or combine them,” the report read.
A greater reliance on securities financing – such as repo and securities lending transactions – will render collateral management systems more important to buy-side trading strategies as firms maximise collateral to reduce overall trading costs. In particular, CCPs may require intra-day initial and variation margin to trade cleared OTC derivatives, putting greater collateral stresses on the buy-side.
“Increased initial margin requirements and daily liquidity needs will impact the financing and opportunity cost of securities inventory and compel firms to manage daily funding needs more closely to ensure assets are managed and collateral is posted in an optimal manner,” the report read.
Commenting on the report, Sean Owens, director of fixed income at Woodbine and report author, said the advent of central clearing, margin requirements and the cost of collateral will force many firms to upgrade their capabilities.
“Organisations need systems that provide a flexible, automated workflow that centralises collateral management for all necessary financial instruments. High-powered analytics, forecasting, and inventory management capabilities are essential,” he said.
The report, ‘Collateral Management” Business Requirements and Vendor Solutions’ also included profiles and evaluations of ten collateral management solutions, and stated differences in automation functionality had become a differentiating factor for potential customers.