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Wall Street Taking A Closer Look at Collateral Management

The quiet backwater of collateral management has been stirred up by Bear Stearns' collapse, Lehman's bankruptcy, AIG's near-death and ongoing turmoil in the credit markets.

J. P. Morgan Builds Global Collateral Platform

The largest collateral management service provider in the U.S., J. P. Morgan has seen its collateral management business grow 40 percent over the past several years, according to the firm's Mathieson, who reports that the company began a three-year, multimillion-dollar initiative in July 2007 to build a new technology and operating environment for collateral management to serve its clients as well as internal investment bank and asset management divisions across the Chinese wall.

"Up until the summer of 2007, collateral management, particularly tri-party collateral management, was considered a convenient service to outsource," Mathieson explains. "Organizations knew they needed to hold collateral against lending or trading positions; it was an appropriate risk management activity, but one that could be outsourced to third-party providers that could do it more economically. ... In the summer of 2007 the notion arose -- and it resurfaced in September 2008 -- that collateral management is a risk management tool and function that's core to any decision to lend or to trade. It's gone from a 'nice to have' to an absolute requirement."

Mathieson says she has pursued three primary goals for the collateral management project. The first has been to create a near-real-time view of collateral management for clients. The second, according to Mathieson, is to make collateral management information available globally so that clients can meet liquidity needs around the world and not be limited to using funding or lending facilities in separate time zones. And the third goal is to enable clients to have a virtual global long box that can operate in different jurisdictions with multiple legal entities in multiple time zones to help them lend or source financing from across their legal entities.

So far, the firm has been building basic infrastructure for collateral management activities. As J. P. Morgan's collateral management business has grown rapidly, disparate platforms have been developed in different parts of the world, Mathieson explains. As a result, she says, her group is working to sew these platforms together, with common data infrastructure, risk controls, reporting tools, definitions and client interfaces. Mathieson adds that she hopes this foundation will be completed by the end of the year.

Next year, Mathieson continues, her group will build tools for collateral allocation, rehypothecation of securities, margin management and the virtual global long box. All told, more than 157 people are working on the project, she reports. J. P. Morgan also has partnered with four vendors -- two that specialize in margin management and reconciliation for derivatives, and two that have user design experience for securities market applications -- to build the collateral management platform. Mathieson declines to identify the vendors.

Ultimately, Mathieson says, J. P. Morgan will have a platform that will help clients make collateral management-related investing, lending and borrowing decisions in a near-real-time environment in several time zones around the world. "It will put much more risk management data directly into our clients' hands that fits into the lending, trading and investment decisions they're making," she asserts.

BNY Mellon Ramps Up for New Clients

Like J. P. Morgan, BNY Mellon also has seen its collateral management business expand. The firm handles more than $1.8 trillion dollars' worth of collateral management business. BNY Mellon's global collateral management services team facilitates the tri-party collateral management process, helping to manage its clients' inventory. It also helps firms manage collateral as a risk mitigant.

Buy-side firms that trade derivatives might not have looked closely at their collateral management process before this September, says Scott Linden, the firm's VP and global product manager, derivatives collateral management. But as they dig out from under the effects of the traumatic month, they will. "There will be an echo effect we'll see into 2009 of people looking closely at their collateral management policies, processes and technologies, and thinking about outsourcing this," he contends. "We're starting to hear a little bit of that as people are coming up for air, but I expect to see a lot more in the next three to six months."

As its technology platform, BNY Mellon leverages a tri-party collateral management engine called RepoEdge that typically traffics cash coming in from investors and securities coming in from dealers. "We work with our clients to ensure that there's a broad array of collateral, and that there's not too much of any particular type of collateral, by screening for eligibility and concentration limits," Linden relates.

BNY Mellon is creating new tools to help counterparties check the status of contracts and collateral. "For example, we're developing an innovative service scheduled to debut later this fall that automatically aggregates and nets overall collateral obligations, which minimizes the collateral dealers are required to post and reduces the risks and costs associated with derivative transactions," the firm's Malgieri says.

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