We gather the views of a disparate range of market participants on how collateral management will develop over the next 12 months.
This Thought Leadership article is part of the 2023 Collateral Management Guide,
which can be accessed here.
Many in the industry may assume the market can put UMR to bed and move on to the next thing but for some that will likely be wishful thinking. That is the view of Neil Murphy, business manager triResolve at OSTTRA.
In particular, many phase five & six firms will find themselves caught between not yet completing all UMR steps, and having to monitor IM exposure while slowly making changes to continue on their path to UMR alignment. These firms may be constrained in their ability to move quickly with regards new collateral developments.
“In contrast, those firms that went for a ‘big bang’ approach may benefit from an ability to look at improving their wider processing capabilities,” he says.
Particular areas of focus include increasing adoption of market standards for margin messaging and reconciliation, and increasing levels of automation – both in terms of call workflows and settlement.
“We can also expect to see an increased focus outside the traditional bilateral OTC space with firms looking to leverage those improvements delivered in the OTC space in recent years to benefit cleared and ETD processing,” adds Murphy. “We have already seen evidence of this as firms increase reconciliation across a wider set of products and begin to exchange non-cleared calls electronically.”
If we look at the intersection of collateral funding and liquidity there are a number of different factors in play, such as centralisation/consolidation, and ESG. According to Bimal Kadikar, founder and CEO Transcend, ESG will make the data issue more complex in the short term because there are large amounts of data that need to be integrated into existing platforms for better decision making.
BJ Marcoullier, head of sales at Transcend agrees that centralisation has moved from being a theoretical concept and that it will deliver increased functionality over the next year.
As collateral costs rise, firms will need to look at optimisation in all its forms - which will mean not only using the cheapest collateral to cover calls, but regularly rebalancing across CSAs.
“Beyond that there is pre-trade optimisation to minimise future collateral requirements, back loading OTC trades to clearing houses, netting and compression,” says Trevor Negus, senior product manager at SmartStream. “Then with the help of liquidity tools, treasury optimisation in the form of predicting future calls to manage collateral buffers is the future.”
Another pressing concern for many firms is the skills shortage across the collateral industry. The strategy of outsourcing has left many firms with the skills on ‘how’ to run collateral management, but not the understanding of ‘why’. According to Negus this factory line approach is risky in the long term, so industry business training is important to ensure there is not a future skills gap.
Finally, he adds, there is also a drive to consolidate, so bringing all collateral-focused activity into one solution specialised in that field is important. “Connecting up to complementary systems through electronic API interfaces for optimisation, inventory, credit risk, and settlements allows for an integrated ecosystem.”
According to Jérôme Blais, co-head of triparty collateral management, securities services at BNP Paribas, 2023 will be a recovery year after the rush to initial margin UMR phase six readiness, but also a year to adapt to the new norm of inflation, rapid market changes, and continuing macro-economic and political shifts.
“This will keep market participant on their toes and may limit the ability or bandwidth firms have to engage in transformational projects,” he says. “In this context, ESG will keep on gaining momentum with, probably, a growing need for regulators to set the pace and the rules of the game.”
Eileen Herlihy, global head of trading services sales at J.P. Morgan believes that that the buy-side will have an increased focus on collateral availability over the next year.
“Increased market volatility has highlighted the importance for asset owners with large directional portfolios to have a variety of tools at their disposal for managing their liquidity requirements,” she says. “Market movements have been so significant that in some instances they have forced outright asset liquidation and it has been challenging to mobilise even the most liquid of assets quickly enough to satisfy obligations.”
Focusing on the digital agenda more specifically, she notes that she expects further clarity on the legal and capital considerations around digital assets, which will pave the way for further use cases as industry participants become more comfortable with allocating resources and investing in digital initiatives.
Some of the concept trades of the past 12 months - such as tokenised money market funds – are expected to move beyond pilot trades and as the market gets comfortable with the technology (coupled with the recent collateral squeeze) Herlihy forecasts wider adoption.
Furthermore she expects the developments on DLT repo to continue apace. “Trading activity already available in the market - such as DLT repo - will expand to term, cross-currency and increase the number of collateral markets available,” she adds. “Adoption across the market will become much further reaching.”
Another prediction is that clients will look for ever more sophisticated optimisation solutions driven by the growing complexity of their business. This is due in part to legal entity fragmentation derived from Brexit and the regulatory-driven binding constraints, all of which were exacerbated by the reduction of available inventory throughout this year.
“We see clients take different routes to achieve optimisation: utilising a tri-party agent’s proprietary algorithm, partnering with a vendor, building their own optimisation algorithm in-house, or by employing a combination of these,” says Herlihy.
“As the availability of collateral and trading opportunities tightened throughout 2022, there was an increase in demand for cross-regional expertise as clients looked for introductions to new counterparties, and solutions to mobilise collateral in more complex markets. We anticipate clients’ continued focus on alternative regions to identify new revenue opportunities in 2023.”
Asset aggregators have experienced significant growth over the last 2-3 years with one of the fundamental shifts fuelling this growth being the availability of digital platforms. As these firms mature, focus shifts to a broader product set for their client base with securities lending a natural expansion area.
“The nature of retail investing results in attractive portfolios from a securities lending perspective consisting of a rich supply of ‘special’ securities,” concludes Herlihy.
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