Regulatory initiatives mandating central clearing of standardized OTC derivatives require market participants to pledge and manage margin calls more frequently. This, combined with the limitations on assets eligible for use as initial margin, is leading firms to explore ways to consolidate collateral across asset classes. Such a move would require firms to implement a centralized infrastructure to provide a single view of the collateral pool, balance sheet and collateral obligations — optimizing collateral across the business.
There are three key operational and technology challenges firms will face when tackling this issue. First, legacy infrastructure and support staff have long been product-specific. This has traditionally made it simple for parties on either side of a trade to interact with each other, but presents a challenge for banks looking to centralize and streamline operations between product silos.
Second, even business lines that may look similar on the surface — for example, repurchase agreements (repos) and securities lending — often have operational differences that make centralization efforts difficult. In this example, securities lending requires intraday settlement, which impacts margining throughout the day, while repo margining is a single, daily margin call.
Finally, many firms are reluctant to begin changing over to a centralized system until the regulatory environment is more clearly defined. They need to balance and be cognizant that deadlines for compliance will come up quickly, however, as it is better to start implementing tactical solutions to help optimize collateral management now, so they can be prepared when the next set of regulatory rules are delivered.
While some of these challenges seem daunting, firms are starting to make progress. There are things firms can do to centralize their collateral management processes today. Today, many clients are selecting a product-specific system and building a bespoke architecture around it to aggregate information from other products. This workaround allows firms to get a jump on managing multiple products in a consolidated fashion until a broader range of vendor solutions become available.
Essentially this requires firms to be willing to be innovative and find tactical solutions that will not only work for them in the short-term but will also give them the tools necessary to comply with future regulations and embrace new technologies as they become available. While there is much uncertainty, it is certain that centralization is where the industry is headed, and it is time to start making strides in that direction or risk being left behind.