2016 fis webinar, the economics of collateral management. and making a profit
TRANSCRIPT
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© 2016 The OTC Space Limited2
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Background
© 2016 The OTC Space Limited4
} Going back ten years or more, Collateral Management was in many firms seen as an adjunct to their Operations or Credit risk teams. Given the easy profits from trading, little attention was made to the flow of margin assets or their cost, as these were a side-line in the overall profits of a firm.
} The first step change for a CM team was the arrival of SwapClear in 1999, and the take up of clearing by a core group of banks in 2000 with the drive to automate the clearing process. SwapClear requires Initial Margin which was a new idea for OTC products. Most Credit Support Annexes at the time required net mark-to-market (or Variation Margin as most call it now), and no additional amounts (other than some customised CSAs for FX or Prime Brokerage).
} Initial Margin became a new cost to the CM team, and forged a new relationship with the Repo / Treasury desks – as someone had to bear the funding cost of the IM, and it couldn’t be the CM team itself who have no profit to spend. This became the genesis of an evolving relationship between the front office and the CM teams – and also the Risk Management team to understand why the IM at SwapClear is driven higher or lower, and therefore increasing or decreasing costs.
Speakers
© 2016 The OTC Space Limited5
Ted Allen has specialised in collateral management for nearly 20 years and is currently Director of Business Development for Apex Collateral at FIS. Apex Collateral is FIS's strategic solution for Enterprise Collateral Management. It provides a unique value proposition to manage, trade and optimise collateral assets on a single platform. The Apex Collateral community of clients spans the buy side and sell side in North America, EMEA and APAC. Apex Collateral delivers a compelling solution to the challenges of collateral market reform and the global regulatory environment.
John has worked in capital markets for 15 years+ (10 at Accenture and 5+ as independent consultant). He has extensive experience in derivatives and collateral management having worked both with the sell-side (clearing members) and buy-side (asset managers) and currently focuses on regulatory driven business change. He has previously worked with HSBC, Barclays, Morgan Stanley andAccenture.
Eric specialises in collateral optimisation/trading, funding, liquidity, OTC clearing and client clearing. He currently works on front office collateral optimisation, repo and tri-party repo, liquidity management and short term funding at Commerzbank, and has previously worked with Capco, Goldman Sachs, and Citi Group.
Main Points
© 2016 The OTC Space Limited6
} Is cash still king? 80%+ of margin calls are met with cash but in this low interest rate environment, is this still appropriate?
} What are the platform and infrastructure choices to meet the March 2017 non-cleared OTC collateral regulations?
} How can funds utilise their assets to cover margin calls without reducing their return on investment?
} What you really need from an optimisation approach} What new innovations are happening in collateral
management?
Regulatory and market initiatives
EMIR / DFA etc• CENTRAL CLEARING
• TRADE REPORTING
• MANDATORY RECONCILIATIONS
BCBS IOSCO• FINAL PILLAR OF OTC
MARKETS REFORM
• GLOBAL STANDARDS FOR MARGINING OF NON-CLEARED OTC DERIVATIVES
• PROJECT BLAZER
BASEL III• EXPOSURE
CALCULATIONS AND DISPUTES
• LIQUIDITY RATIOS AND RISK MANAGEMENT
AND OTHERS….• SFTR
• ASSET ENCUMBRANCE
• UCITS, 1940 ACT
• ISDA / ICMA / ISLA BEST PRACTICES
• ….
Challenges• Operational complexity• Regulatory compliance• Increased volumes• Market infrastructure changes
• Increased cost of collateral• Optimisation and Transfer Pricing• Liquidity impacts• Higher capital charges
9
Extra collateral required
$800b
Increase in margin calls
5x
Increase in substitutions
10x
Impact of non-cleared margin rules
JXL Consulting Ltd
Bilateral book fragmentation: derivatives fission
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1
2
3
4
51. LegacyBilateral
2. NewBilateral
3. Cleared(Mandated)
4. Cleared(Elective)
5. NewProductse.g.Listedhybrids
Market changes will significantly change the composition of a typical derivatives portfolio over the next few years | a theoretical evolution of categories
Un-cleared Bilateral Margin Rules
11
•Possible Delay to the Implementation of the Rules– EU rules still not final, being reviewed as we speak– “Our objective is to deliver the standard before the end of the year [2016] and
for firms covered by the first wave of the rules to be required to comply before the middle of next year [2017],” said a Commission spokesperson.– Bloomberg: http://bit.ly/BBGUMRDelay– IFR: http://bit.ly/ifrumrdelay
•European Commission may delay implementation for six months – From September 2016 to March 2017 for IM & VM for tier 1 firms– From March 2017 to September 2017 for all firms subject to VM
•No change to US rules timing – leading to a US disadvantage?•Brexit effect?
13
How familiar are you with the upcoming BCBS IOSCO regulations for margining of
non-cleared OTC derivatives:
1. Deeply and intimately familiar2. Pretty familiar3. A bit worried I should know more4. I don’t understand the question
17
What is your biggest problem in preparing for BCBS IOSCO rules for margining of non-
cleared OTC derivatives:
1. Negotiation of new regulatory CSAs2. Preparing operations processes 3. Technology and infrastructure4. Managing the cost of collateral5. Something else
JXL Consulting Ltd
Collateral Trends
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Cash Drivers
• Dealer preference for cash only CSAs
• Cleared VM required in cash
• Cash operationally easier
• Current investment environment favours cash
Non cash Drivers
• Fully invested funds prefer non cash
• Some CMs favour non cash for cleared IM
• Increasing cleared IM materiality
• Extension of CCP eligible asset types
• Cash negative rates favour non cash
There is likely to be a gradual shift in favour of non cash
Managing the Cost of Collateral
•Funding•Returns•Opportunity Cost•xVA & Pricing•Cheapest to deliver Bonds versus Operational capabilities
JXL Consulting Ltd
How can funds utilise assets?
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• One size does not fit all in the fund universe.
• Whilst some funds can easily post additional collateral from existing inventory, others (esp pension funds) will struggle to avoid impacting fund returns.
• Any mitigation strategy should be twofold:-Razor focus on reducing “demand” [root cause]-Deploy multiple strategies to make best use of available asset sources
• Asset source optimisation could include:-Change in use of derivatives-Collateral transformation by CMs-Collateral transformation by CCPs-Securities lending-Peer to peer repo-Use of alternative products (e.g. swap futures)
Centralized profit center to unlock the potential of collateral management – Sell Side View?
24
Market trend
Central collateral/liquidity management and trading unitCollateral management(Cross product collateralization)
Liquidity management(Repo / reverse repo)
Enterprise collateral inventoryCross-asset, real-time
Securities lending / collateral trading
Collateral optimisation / collateral transfer pricing
Central view of inventory
Operational efficiency
Enable collateral trading and improve ratio management
26
Has your firm established a program to centralise collateral management?
1. Yes, it has been centralised2. Yes, it is an ongoing initiative3. No – but it’s in our plans4. No – we will never do this5. Something else
JXL Consulting Ltd
Infrastructure Building Blocks
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A 5 year strategy is essential to deliver the right infrastructure at the right time
2016 2017 2018 2019
IMSim
Cat2IRSClearing
Cat2CDSClearing,
PRIIPs
UnclearedVM
PensionExemption,
MiFID2
UnclearedIM
Pre-TradePost Trade CCP
CollateralMgt
Capacity
Limit Monitoring
VenueSelection
Cost of Collateral
CollateralTransform
Fee Simulations
Feeoversight
Tierassessment
Clearing Eligibility
TreasuryMgt
Intra-day margining
CrossMargining
Concentr.Limits
UnclearedIM
DirectClearing
FundAccounting
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What is the state of collateral optimisation at your firm?
1. No need for optimisation2. We are studying the business case3. We are investing in a program4. We have an established collateral optimisation process5. Something else
JXL Consulting Ltd28/06/2016 34
Post tradeCollateral
Optimisation
Pre-tradeCollateral
Determination
•Cross margining
•Cleared IM optimisation
•Bilateral IM
•Accurate cash inventory
•Accurate non cash inventory
•Availability of unsecured financing
•Cost of collateral methodology
•Algorithm to attribute cost over multiple fund managers in one margining pot
•Daily review of collateral
•Substitution over events
•Accurate cost attribution
Optimisation Value Chain
CaptureConstraints
EvaluateSupply
MinimiseDemand
•Haircuts and eligibility
•Concentration restrictions
•Investment restrictions
•Holding costs (e.g. LDR)
Collateral Transformation
“Optimisation” is in reality a number of distinct components
Global InventoryAvailability ladder of positions
Requirements
• cOTC / ETD• Bilateral• Funding• … Requirement 1 Requirement 2 Requirement N
Constraints
• Substitution & Concentration limits• Eligibility & haircuts• Corporate actions• Settlement cut-offs• …
Eligibility 1 Eligibility 2 Eligibility N
Position1 Position 2 Position n
Complexity: How to achieve a holistic allocation that meets all constraints and minimises cost Scale: automate the allocation process – automatic collateral trade creation
Holistic Numerical OptimizationOptimal Allocations:- Minimize costs
- Maximize liquidity
Holistic Post-Trade Collateral Optimization
Final Question
© 2016 The OTC Space Limited37
} What is the “assets shortfall?”} Why might this happen?} When might this happen?} What are the consequences?} Is there any evidence for this?} Does the audience have any views?} Let us know using the Questions panel
Next Steps
© 2016 The OTC Space Limited39
} What should your firm be doing?} Review the current economic effect of your
collateral management activities} Review your operational and technical platforms} Look cross-business (OTC, Repo, Exchanges,
Stock Loan)} Establish an Owner / Sponsor for your Strategy
(if you don’t already have one)
Contact Details
© 2016 The OTC Space Limited40
} Ted Allen} Email: [email protected]} Phone: +44 20 8081 3065