Collateral management is increasingly moving to the front office as it becomes more central to the investment process, according to research by consultancy Sapient Global Markets.
Sapient’s survey of institutional investors, CCPs and custodians found that while most still position collateral functions in the back office, regulatory change is driving the importance of collateral management, with 25% of respondents saying they plan to move this function to the middle or front office.
Requirements to centrally clear OTC derivatives transactions in regulations such as the Dodd-Frank Act in the US and European market infrastructure regulation, are behind this change, but the need to save money plays its part with some respondents hoping to turn collateral into a revenue generator.
While 66% of firms surveyed saw collateral management as a cost center, 39% have plans to turn it into a profit generating part of their business.
However, Sapient said many firms are not properly optimising collateral. This has an impact on their ability to realise a strong return on equity.
Most are still primarily focused on compliance with new regulation or on cutting costs. Few are optimising collateral use to increase revenue though a number of firms are planning to fine tune collateral management, and the sell-side is aiming to capitalise on this.
For the buy-side, outsourcing collateral management has become a core focus.
Currently, 43% of asset managers surveyed said they have appointed a third party to manage collateral, primarily to help them become compliant with new regulations and reduce collateral management costs.
On the other side, custodians and banks want to be able to supply this buy-side need, with almost half planning to offer collateral management as a service to clients.
Most expect the cost of collateral to rise and become a bottleneck with counterparties. Respondents expected collateral demand and restrictions on re-hypothecation to be key drivers of higher costs as more asset classes become subject to collateral and margin requirements.
However, most do not expect a widespread shortage of collateral despite the increased demand, but they are concerned about the impact this could have on liquidity.