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The paper examines the market implications and costs of bilateral OTC derivatives collateral settlement fails. A collateral settlement fail occurs when cash or securities collateral is not delivered or received on the agreed date.
Beginning in September 2016, new rules for bilateral clearing of OTC derivatives are projected to significantly increase the number of collateral movements between market participants. If the current 3 per cent settlement fail rates for collateral movements prevail, the white paper suggests that the operational cost will quickly become unsustainably burdensome, especially for buy-side firms. At the same time, there is a risk that the problems that cause settlement fails – commonly identified as miscommunication, constrained technology, insufficient collateral and counterparty insolvency – may be exacerbated, given the complex changes that will be required to OTC derivatives workflows and documentation alongside increased margin call volumes.
Regulatory mandates, including Dodd-Frank Act (DFA), European Markets Infrastructure Regulation (EMIR), and Basel III in addition to the BCBS-IOSCO uncleared/bilateral margin requirements framework, will create an increase in the number of margin calls, collateral delivery channels, and collateral movements across market participant firms. Additionally, existing collateral agreements may need to be amended, created, or replaced to comply with regulatory requirements. The breadth and depth of these regulations pose significant challenges for participants in the bilateral OTC derivatives market.
Mark Jennis, Executive Chairman of DTCC-Euroclear GlobalCollateral, adds: “It is becoming increasingly important that firms assess and improve their current collateral and margin management processes, as regulatory obligations continue to increase. With current rate of collateral fails, combined with the expected increase in margin and collateral calls, firms must act now and ensure they can meet these impending challenges.”