Nearly 50% of buy-side firms have yet to make operational adjustments for collateral requirements under new OTC derivatives rules - an investment that will cost the finance industry US$53 billion in infrastructure and technology, according to a new report.
Celent, a US-based financial research and consulting firm, released a survey on institutional investors' adoption of new services to achieve greater collateral efficiency, ahead of regulatory changes.
Both the US Dodd-Frank Act and the European market infrastructure regulation require many types of OTC derivatives transactions to be collateralised and centrally cleared. Coupled with tougher global capital adequacy rules for banks under Basel III, market participants fear a shortage of high-quality collateral.
Celent found the scope and pace of regulation were creating operational challenges for buy-side firms, with more than 90% of about 25 respondents saying they were feeling the pressure.
One area of significant concern was the firms' ability to cope with an anticipated 100-150% growth in margin call traffic, as even a 50% increase could be "problematic," the report said.
Celent found that 48% of firms had not completed operational preparations, and from those that had, 43% reported inefficiencies and 38% citied systems limitations.
More than 60% of firms identified a need to focus on collateral and operational efficiency, with automation of collateral management part of the way forward.
"Whether or not a firm is proactive in terms of implementing the right infrastructure to manage and optimise collateral, we expect trading and investment strategies will need to change,"Cubillas Ding, Celent research director and author of the report, said.
"The differentiator between winners and losers will entail frontline strategy decisions that are enabled by timely collateral inventory information and margining operations, as opposed to firms that may face limitations on what/how/where they trade."
Collateral as commodity
According to a survey by post-trade services provider SIX Securities Services, 70% of financial institutions believe collateral management has become or is at risk of becoming a commodity.
Bob Almanas, managing director for international services, said while the focus should be on optimising available collateral through services, there was concern central counterparties could compete for business on the basis of collateral quality.
Almanas said scarcity might lead industry participants to "re-package" collateral that lacked quality and liquidity, thereby increasing rather than reducing systemic risk in OTC derivatives trading.
"In this economical environment and given lessons that we've learned from the financial crisis, we don't need a race to the bottom when it comes to the quality of collateral that is accepted," he said.