Banks are struggling to capture market share as they are forced to restructure their organisations to best meet evolving global and regional regulatory requirements. Regional mandates create a unique challenge, even while global regulatory bodies diligently work together to minimise arbitrage rule sets.
Banks are struggling to capture market share as they are forced to restructure their organisations to best meet evolving global and regional regulatory requirements. Regional mandates create a unique challenge, even while global regulatory bodies diligently work together to minimise arbitrage rule sets. The increased collateral requirements for both cleared and non-cleared trades have pressured banks to manage the process while keeping high quality liquid collateral readily available. Collateral transformation and optimisation have become important areas within banks to maximise return and reduce costs.
As volumes of exchange-traded derivatives increase, banks must invest heavily in robust supporting technology, often requiring the complex addition of new functionalities to the bank’s existing legacy systems. Banks are further constrained by bifurcated processes for bilateral and exchange-traded derivatives, which create heightened complexity for the operations, compliance and collateral management processes. These institutions will need to support two sets of technology; one for exchange-traded derivatives and another for bilateral trades. While bilateral trades will decline in volume, they will never be completely dissolved, so banks must know how to efficiently process and manage these for all clients.
The regional deal
Regional requirements have impacted how banks are dealing with collateral requirements and managing processes for clients. For example, Dodd-Frank is very descriptive in requirements, deadlines and rules, whereas EMIR has led with a more principle-based outlook, allowing an objective-focused set of rules with great flexibility around implementation. As a result of the sheer number of many smaller banks’ clients which have waited to see how regulations would be deployed before taking action, there is now a long list of clients that banks are trying to onboard. Some global firms have recognised the inevitable inefficiencies in implementing the correct strategies in house around these complex and multiple rules and have opted to leverage a third party resource to execute and manage these processes. Such third party operations support resources specialised in these processes and, by virtue of this specialised domain expertise, provide these global firms with cost reduction and elimination of the possibility of inaccuracy from internal operations related to clearing, risk profiling, collateral requirements, and reporting.
Credit Support Annex (CSA) agreements have shown a distinct need for remediation services in order to extract accurate data for collateral optimisation performance. It is critically important that banks understand the data contained within their CSA documents. However, it has been found that over 50 percent of all fields captured by banks within their CSA agreements do not match against the data they have recorded in their internal systems. Extracting this metadata accurately has become a high priority for both clearing and bilateral trades in order to perform effective collateral optimisation.
Tied closely to collateral management, risk is a key player in day-to-day operations, specifically for central counterparty clearing houses (CCPs). The true cost of clearing at a particular CCP may vary greatly depending on the volume and specific product types that the client decides to execute. Different margining models will create varied pricing and funding implications for each clearing member. As a result, CCPs are under pressure to accurately calculate risk in order to collect the correct collateral required for each member. CCPs will be working closely on this process as banks have historically had the upper hand in performance of detailed risk analysis for clients. Regulations such as Dodd-Frank and EMIR lay out a competitive landscape for CCPs and the conflict between cost-effectiveness and the degree to which CCPS can mitigate risk remains in play. Before the true levels of risk can be identified, there are a number of issues that must be resolved, such as how CCPs respond to their members’ needs in a stressed market environment in which collateral is more illiquid, as well as what hidden risks might be associated with a CCP’s connection in the global banking system.
A look to the future of clearing
As banks invest in technology and restructure legacy systems—all of which can be extremely costly— more firms are leveraging third-party partners to alleviate this burden while maximising return and efficiencies. Working with a business process service provider that can handle the entire trade work flow—for cleared and non-cleared trades—can help banks lower costs as volumes shift and more trades are cleared over an exchange. Collateral transformation will allow clients of clearing members to post available securities that can then be transformed into the required high quality collateral for margin, while market participants will be focused on activities that will help them to use and create collateral in the most efficient ways.
