29 May 2014

DerivSource: EMIR changes collateral management choices

Managing cash as collateral is relatively easy and is a good starting point. However, the process gets more complicated when securities are used as collateral, which will undoubtedly become necessary to support larger and more frequent margin calls for cleared and uncleared derivatives in the near term. The use of securities, but also the general business needs of the firm in question, will require many to adopt more sophisticated collateral management tools and develop expertise to conduct eligibility and reference checks, cheapest to deliver algorithms and settlement processes for instance. 

Investing in a collateral management system to manage these more sophisticated but essential functions is one option but this limits the firm's ability to pick and choose additional functionalities it may need in future. Investing in in-house systems can also be expensive in terms of license fees, time and necessary resources to implement and integrate the system with other internal procedures such as SWIFT messaging. These costs should not be underestimated, especially as they are added to the normal profit and loss costs.

In comparison, depending on the level of activity, it may be more cost-effective for a market participant to select an outsourced solution to avoid the costs associated with licensing and maintaining the system. Outsourcing generally reduces operating costs over time but also allows a firm to reallocate their manpower to more value-added areas such as dispute resolution and risk management. Firms that opt to outsource collateral management to a service provider will have readymade access to more sophisticated collateral management functionalities such as collateral optimisation algorithms and funding services. Such advanced collateral tools may become increasingly necessary as the market as well as the needs of the organisation evolve. 

Outsourced collateral management solutions bring both qualitative and quantitative cost savings. Many operational managers may currently have team members who are working on the system but lack the expertise to upgrade it to manage the greater volumes and complexity resulting from upcoming regulations. This is a qualitative cost that financial institutions should take into account when setting up their collateral management solutions. From a quantitative perspective, we expect our customers to reallocate resources which reduces costs by 50 to 70 per cent, even when taking ongoing service fees into account. Furthermore, outsourced collateral management services improve operational efficiency and reduce regulatory costs without sacrificing expertise or the availability of more sophisticated functionalities and tools.

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