As part of the post-crisis financial markets overhaul, global regulators are forcing standardised OTC derivatives through central clearing, while all uncleared transactions will be subjected to higher margin requirements. Launched in parallel with tougher capital requirements for banks, the outcome is a collateral challenge for the whole industry.
Consulting firm Oliver Wyman estimates that additional collateral requirements for cleared swaps will increase from US$600 billion today, to a whopping US$1.9 trillion by 2020.
The pace of demand for collateral is likely to pick up later this year as margin rules for bilateral OTC derivatives trades begin to take hold in Europe and the US.
The tone of industry debate has changed somewhat over the past year, with the term ‘collateral crunch’ slowly being squeezed out by perceptions that there is enough to go around.
“We understand what the building blocks of this collateral space are now, that is slowly becoming clearer,” said Ben Shepherd, partner, Oliver Wyman. “We are beyond this language of collateral crunch. The view is that there is enough collateral in the system.”
Cleaning the pipes
While the collateral panic may be over for the moment, the market is now facing operational and financial hurdles as it scrambles to plan for the increased regulatory burden.
A major issue is going to be allocating and mobilising capital across the globe along with the challenges of reporting, integrating and sourcing collateral, i.e. upgrading the plumbing which underpins the whole collateral framework.
The solution, according to a general consensus of those discussing ‘The evolving collateral challenge – where will it end?’ at Sibos 2014, is to pull together as an industry.
“The movement of collateral is a hot issue. It is not just for the future it is for today,” said Ruud Sleenhoff, head of industry engagement, business services, RBS. “Sell-side, buy-side, everyone is talking about collateral, but talking the same language here is critical.”
Ila Eckhoff, director of derivatives operations, BlackRock, echoed the idea of unity within the industry, through working groups and collaboration.
“We are really not on different sides, we are just different pieces on the chain,” she said. “The industry has come a long way, but we have to keep moving forward. The better we build the infrastructure and the cleaner we can keep the pipes, then the better the flow.”
Collateral movement has become an intraday activity and firms are expected to move collateral around much quicker under new rules. The industry has subsequently become concerned with operational and technical capabilities such as poor data management.
As with derivatives clearing, messaging and financial crime compliance, the answer to these dilemmas may lie in the development of utilities. In Oliver Wyman’s survey, the majority respondents agreed that a central counterparty-like solution could be used.
“Most responses were looking to industry solutions and utilities,” added Shepherd. “Utilities used to be something that was a conceptual myth, but they probably will feature heavily on the collateral landscape."
In terms of who would be set to provide the utilities, banking consortiums are leading the charge in this space, however respondents to the survey called for custodians, software providers and central securities depositories to step forward also.
Florence Bonnevay, head of market and financing services, BNP Paribas Securities Services, concurred, saying, “Custodians are quite nicely placed, but again it has to be in partnership with the whole value chain.”
Greater engagement
One existing response has been from post-trade service providers Depository Trust & Clearing Corporation (DTCC) and Euroclear, which have teamed up to create a new margin settlement process with straight-through processing.
Mark Jennis, managing director, collateral management, strategy and business development at the DTCC, said, “Firms are very concerned about being ready for all the regulation that is upcoming. We are seeing far more engagement than ever.
“The desire is to have more solutions that are front-to-back rather than fragmented. We set up this joint venture because we had such interest in utilitisation.”
Jennis said the development of utility solutions required a collaborative effort, meaning the industry would have to work even closer together.
BlackRock’s Eckhoff, continued, “We are dependent as an industry on all of us being at a certain level of understanding. It is really critical that we move this stuff forward.”