Cooking up a collateral treat
12 June 2018
Ed Hellaby, business development director of FIS, suggests it is time to ‘mise en place’ your collateral operation
Image: Shutterstock
Have you ever wondered how it is that a professional chef can turn out a full service of dishes in parallel, while your attempt to whip up anything more than an omelet and coffee at the same time leads to a trail of destruction and charred pans? You could say it is a skill that the chef has honed over years of cooking—and it is, of course, true; years of practice go a long way toward being able to master a myriad of dishes and the associated time management to ensure they all come out together. Or perhaps you would put it down to the quality of the equipment they have at their disposal—but then, you also know that some restaurant kitchens in our capital cities are no larger than a suburban closet. For the real ‘secret sauce’, we must look to a French term well utilised in the culinary world, ‘mise en place’. Unlike most of us, professional chefs do not prepare each step of a menu as they arrive upon it; instead, they will ensure each and every ingredient is pre-washed, weighed and prepared. They mise en place their kitchen, which simply means, ‘to put everything into place’. This allows a chef to efficiently assemble dishes by adding their ingredients at just the right time, in just the right quantity. At this point you may be wondering what any of this has to do with collateral management—and my answer would be: quite a bit.
Over the past two years, we have seen a swathe of regulation generate the need to raise and mobilise both cash and non-cash collateral on a T0 or T1 basis. As the uncleared margin rules (UMR) continue to come into effect for new waves of market participant, the demands on liquidity and operations processing is set to climb. At a recent collateral forum, an industry veteran estimated that upward of $105 billion is now collected daily to cover initial margin (IM) obligations off the back of UMR for the phase one and two participants. This is on top of the existing margin requirements for cleared and non-cleared trades.
One of the key challenges facing collateral management teams on the buy side is ensuring there is sufficient liquidity available to meet their variation margin (VM) calls on a same day basis, while maintaining the lowest possible cash buffers to avoid a drag on performance. An intrinsic part of a collateral manager’s daily job is now to ensure they can accurately determine tomorrow’s VM and ensure they have worked with treasury to ensure they raise the cash they need. This mise en place of the cash is generally achieved by lending out their assets. The sooner and more accurately you do it, the better the outcome. Advanced collateral management solutions, such as FIS’s Apex Collateral, are able to perform these kinds of ‘what-if’ calculations for VM to produce reports that can be passed to the treasury and funding groups automatically.
In a similar ilk, the buy-side can also expect to be hit hard by the demand to post IM for their uncleared trades. IM requirements for the most part must be satisfied with high-quality liquid assets (HQLA), something an asset manager may not be holding in sufficient quantities. An increasing trend on the buy side is to leverage post-trade optimisation to ensure that they are effectively using their existing portfolio of assets to its full extent. However, where there are shortfalls in inventory, they will likely have to turn to the securities lending markets to perform upgrade trades to raise sufficient levels of HQLA. As we are still two years away from the margin rules being fully in effect, we cannot be certain what kind of liquidity squeeze this will place on the market. However, we can be sure of one thing: with a rising interest rate environment and an increased demand for HQLA, we will see higher costs of borrowing in the securities lending markets. While this may be a boon for the beneficial owner community, it will likely eat further into the shrinking margins for actively-managed funds.
Due to growing demand for access to the repo and securities lending markets, the buy side are increasingly looking at setting up dedicated collateral financing/trading desks tasked with executing repo and securities lending transactions to raise the right kind of collateral. For those organisations new to this space, trying to determine where this process will fit in their overall process and system architecture is no simple task. Those lucky enough to already have an enterprise collateral management system with a real-time view of global inventory that can also support repo and securities lending trading, it may be as simple as flipping a switch to activate this functionality. For others with legacy in-house technology, or just a collateral operations solution, the road ahead may be a little more convoluted. Complex integration with trading platforms or third-party agents will need to be done to ensure that as the desk executes a trade and raises collateral, the positions show as available inventory for use within the collateral platform. This real-time flow of data is essential for anyone who may be looking to use any form of optimisation engine to most efficiently allocate inventory across the competing requirements for VM, IM and alpha generation through the lending programme.
We can think of the next chapter of collateral management the same way as we would a chef walking on to the line for a busy Saturday service. If we put into place a process that lets us determine and source exactly what collateral we need, where and when we need it, we put ourselves in the best position to succeed. And just like a chef, if we fail to mise en place our collateral operations, we will quickly find ourselves looking for a new kitchen.
Over the past two years, we have seen a swathe of regulation generate the need to raise and mobilise both cash and non-cash collateral on a T0 or T1 basis. As the uncleared margin rules (UMR) continue to come into effect for new waves of market participant, the demands on liquidity and operations processing is set to climb. At a recent collateral forum, an industry veteran estimated that upward of $105 billion is now collected daily to cover initial margin (IM) obligations off the back of UMR for the phase one and two participants. This is on top of the existing margin requirements for cleared and non-cleared trades.
One of the key challenges facing collateral management teams on the buy side is ensuring there is sufficient liquidity available to meet their variation margin (VM) calls on a same day basis, while maintaining the lowest possible cash buffers to avoid a drag on performance. An intrinsic part of a collateral manager’s daily job is now to ensure they can accurately determine tomorrow’s VM and ensure they have worked with treasury to ensure they raise the cash they need. This mise en place of the cash is generally achieved by lending out their assets. The sooner and more accurately you do it, the better the outcome. Advanced collateral management solutions, such as FIS’s Apex Collateral, are able to perform these kinds of ‘what-if’ calculations for VM to produce reports that can be passed to the treasury and funding groups automatically.
In a similar ilk, the buy-side can also expect to be hit hard by the demand to post IM for their uncleared trades. IM requirements for the most part must be satisfied with high-quality liquid assets (HQLA), something an asset manager may not be holding in sufficient quantities. An increasing trend on the buy side is to leverage post-trade optimisation to ensure that they are effectively using their existing portfolio of assets to its full extent. However, where there are shortfalls in inventory, they will likely have to turn to the securities lending markets to perform upgrade trades to raise sufficient levels of HQLA. As we are still two years away from the margin rules being fully in effect, we cannot be certain what kind of liquidity squeeze this will place on the market. However, we can be sure of one thing: with a rising interest rate environment and an increased demand for HQLA, we will see higher costs of borrowing in the securities lending markets. While this may be a boon for the beneficial owner community, it will likely eat further into the shrinking margins for actively-managed funds.
Due to growing demand for access to the repo and securities lending markets, the buy side are increasingly looking at setting up dedicated collateral financing/trading desks tasked with executing repo and securities lending transactions to raise the right kind of collateral. For those organisations new to this space, trying to determine where this process will fit in their overall process and system architecture is no simple task. Those lucky enough to already have an enterprise collateral management system with a real-time view of global inventory that can also support repo and securities lending trading, it may be as simple as flipping a switch to activate this functionality. For others with legacy in-house technology, or just a collateral operations solution, the road ahead may be a little more convoluted. Complex integration with trading platforms or third-party agents will need to be done to ensure that as the desk executes a trade and raises collateral, the positions show as available inventory for use within the collateral platform. This real-time flow of data is essential for anyone who may be looking to use any form of optimisation engine to most efficiently allocate inventory across the competing requirements for VM, IM and alpha generation through the lending programme.
We can think of the next chapter of collateral management the same way as we would a chef walking on to the line for a busy Saturday service. If we put into place a process that lets us determine and source exactly what collateral we need, where and when we need it, we put ourselves in the best position to succeed. And just like a chef, if we fail to mise en place our collateral operations, we will quickly find ourselves looking for a new kitchen.
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