Regulation and changing market dynamics have moved collateral into the spotlight and have had a profound effect on how market participants pursue their trading and investment strategies.
In this third paper in our collateral management series, we explore a range of innovative solutions available from BNY Mellon that can help financial institutions and institutional investors meet today’s collateral challenges.
Executive Vice President
BNY Mellon Markets
Collateral plays a central role in today’s financial marketplace. Regulation and changing market dynamics have moved collateral into the spotlight, creating new challenges for market participants as they pursue their trading and investment strategies. Indeed for collateral management, the move continues from a classic back office processing function to more of an all-encompassing back-middle-front office set of services, aims and objectives. Financial institutions and broker-dealers face increasing capital costs which have affected their trading activities and made them more selective in how they use their capital as collateral. This behavior change is having a ripple effect throughout the market and is transforming how institutional investors (e.g., pensions, insurance companies, asset managers and corporate treasurers) view and generate value and apply collateral. Today’s market provides opportunities for institutional investors to become more active in collateral transformation and market supply, a role traditionally seen as a function of the banks. In addition, there is a growing list of transactions requiring collateralization which is transforming the institutional investor business model. With these trends, institutional investors will need to spend more time, energy and talent on managing collateral and understanding how to use it efficiently and effectively.
Head of Collateral Management Product
BNY Mellon Markets
Head of Collateral Segregation Product
BNY Mellon Markets
As new regulations come into force, the impact on the demand for and supply of collateral is causing the value of collateral to increase, resulting in a significant shift in the structure of the funding market. In this section we list for you a range of ideas and options that may help you to manage your collateral process with heightened efficiency.
Collateral demand is on the rise due to regulatory requirements, including liquidity ratio calculations and the upcoming margin rules for over-the-counter (OTC) derivatives trades. In particular, high quality liquid assets (HQLA) (e.g., cash and US Treasuries) are in shorter supply as regulations require that banks and broker-dealers keep HQLA on their balance sheets rather than using them as collateral thereby suppressing HQLA availability and velocity. European and US quantitative easing (QE) programs have further affected HQLA availability by converting HQLA in the market to excess balance sheet deposit liabilities with the banks. Furthermore, re-use constraints on posted margin “lock up” the collateral with third-party custodians which can also restrict collateral mobility.
With the growing demand for quality collateral and the increasing pace of regulatory change, market participants are seeking new collateral sources and ways to help them manage the transformation process. BNY Mellon helps clients manage regulatory requirements and capital needs and optimize their portfolio assets by continually expanding the supply of assets accepted in its collateral management program.
With regulation and market changes placing a premium on collateral, market participants need to be more efficient when financing transactions. Allocating the least expensive collateral to each trade, having a full view of which collateral is being used and which is available and applying efficient collateral management techniques to a variety of transactions all help market participants use their eligible assets efficiently and manage financing costs.
Using Assets Efficiently
Due to regulation, broker-dealers and financial institutions continue to deleverage and use longer-term financing structures rather than short-term wholesale funding. Heightened balance sheet controls make it ever more important for them to deploy collateral efficiently across their global asset pools. In response, broker-dealers and financial institutions are finding new trading techniques which are more balance sheet friendly and more efficient in terms of collateral usage. Swaps, secured notes and alternative collateral forms may help with balance sheet management and are rising in popularity. In addition, some broker-dealers are exploring the use of collateral pledge structures as opposed to transfer of title in order to achieve better capital treatment for transactions. BNY Mellon is working alongside its clients to help adopt these new techniques into day-to-day operations.
Global regulatory reform is reshaping and redefining the way institutions are required to post initial and variation margin, manage collateral and segregate assets. While the implementation dates for the changes and new requirements vary, there will be a significant impact on market participants’ business models. As the new initial margin requirements are implemented beginning September 2016, we are shaping solutions that maintain a high degree of automation while focusing on controls, risk mitigation, efficiency and transparency.
BNY Mellon is a pioneer in providing collateral solutions around the globe. Please read our case studies and discover how our collateral ideas, insight and vision can help you keep moving forward with the markets, and along the way, help to improve the efficiency of your collateral management activities.
Consultants are also speaking to their clients about collateral. Thomas Ciulla, PricewaterhouseCoopers, New York, Nick Nicholls, Business Consulting Lead, GFT, UK, and Kishore Ramakrishnan, PricewaterhouseCoopers, Hong Kong, describe the trends they are seeing around collateral management and collateral segregation.
Q. What kind of engagements are you usually called in for related to collateral management and segregation?
Nick Nicholls – Our clients are predominantly broker-dealers and European investment banks. With the larger broker-dealers, the focus is optimization and meeting regulatory compliance while some of our tier 1 bank clients are looking to move to an enterprise-wide collateral strategy to manage both counterparty credit and funding. We also work with clients as they review their current collateral management process. These clients may have governance issues or process gaps and are often looking to develop a best practice within their organization.
Clearly, buy-side institutions are impacted by whatever constraints the banks have to endure. Our focus with those clients at the moment is explaining or reinforcing the potential impact of regulatory reform on their business
Thomas Ciulla – PwC has had a dedicated collateral management and liquidity practice for over a decade and in short, we do everything but security perfection. Across the sell side, buy side, and custody banks, we are helping clients in a variety of areas. For some, we are developing strategies to meet the impending bilateral margining rules, but we are also breaking down cross-product silos (OTC derivatives, repo, SBL) to achieve liquidity and operational efficiency. Improving efficiency, while meeting regulatory mandates, is particularly important with sell-side clients who are invariably under pressure to reduce costs (often through shared services and utilization).
We also work closely with buy side clients. For many of these clients, “repapering” ISDA CSAs is a priority. For others, who have not exchanged margin through automation as mandated by regulators, we are helping them move from spread sheets to either vendor packages or outsourced solutions (very often from service providers such as BNY Mellon).
Kishore Ramakrishnan – Additionally in Asia, each of the market participants have a different set of challenges and priorities as they look through the lens of “asset protection/asset safety” and “operational efficiency” when addressing “segregation” mandates. PwC assists these firms in implementing the segregation rules that involve establishing custodian accounts by connecting to custodians alongside negotiating tri-party control agreements and account control agreements.
Q. In your conversations with the street, what are the top concerns regarding collateral management and how do you see firms dealing with it?
Kishore Ramakrishnan – When I speak to clients in Asia-Pacific, they are concerned with assessing the impact of collateral/margin requirements from a capital/balance sheet standpoint. Firms are working towards identifying the least common denominator in the intersection of Basel capital rules, leverage rules, funding rules and their bearing on the firm’s collateral/margin imperatives. Firms are also equally concerned about dealing with operational challenges as they pertain to cross-border transactions due to divergent approaches to collateral regulations in each region.
Thomas Ciulla – Adding to Kishore’s points, clients in the US, are gathering momentum for the September 1 deadline while others are preparing for the March 2017 mandatory variation margin (VM) requirements. Many participants exchange VM regularly, so preparing for the regulations entails developing an approach to handle increased margin call volumes. Correspondingly, many participants are developing regulatory complaint documentation that is driving the increase in margin calls. This is a significant issue as organizations can have as many as four CSAs active for any given portfolio (legacy VM, regulatory VM, legacy IM, regulatory IM). However, organizations must first understand the P/L impact of migrating legacy agreements to regulatory complaint ones against the operational burden of managing multiple CSAs per margin event.
Senior Product Manager
BNY Mellon Markets
Senior Business Development Manager, EMEA
BNY Mellon Markets
We believe the collateral management industry is at the cusp of change that will have a significant impact across market participants (i.e., sell side, buy side, custodians and clearing members). The complexity continues to grow with multiple regulatory changes and the varying approaches to meet the demands of local regulatory bodies. Consequently, market participants will need to evolve and create exposures to asset classes through new structures and broaden access to collateral asset types. A key theme thus far addressed in this document has been
We hope that you have enjoyed reading this paper, recognizing some of the challenges faced with collateral management post regulatory reform. We have a broad range of people, business experience and technical capability at BNY Mellon, all ready to help you develop your business and work with you to deliver the very best in collateral management. You have met some of our team through reading this paper and now we welcome you to meet us in person.