Much has been written about the pressures on banks in a highly regulated post-crisis market. Less discussed are the myriad of operational challenges that have since emerged, creating new layers of complication. Added to this, political and institutional
bad news stories continue to send ripples through the sector, prompting banks to assess the many possible implications to their balance sheets.
OTC derivatives took a lot of the blame for the economic crisis, with poor risk management at the heart of the debate. Since then, Dodd Frank and EMIR have sought to protect the market with central clearing, although these introduce greater capital requirements.
One problem is that the demand to meet margin calls from central counterparties could result in a shortage of high quality collateral. This in turn is leading to a renewed focus on collateral optimisation, as banks review their inventories and source or transform
the necessary assets, typically with the realisation that there are significant gaps in their understanding of collateral constraints and key economic and legal terms.
In a crisis the path of least resistance to 'patch-up' poor data is the creation of a ‘million dollar spreadsheet’.
Large banks are often weighed down with the plethora of documentation that goes with securing and managing relationships with thousands of OTC derivatives counterparties. This is usually industry standard paperwork covering initial and variation margin requirements,
eligible collateral, close-out conditions in the event of a crisis, and a range of other scenarios, running into many pages of relatively unstructured data. The collateral documentation for OTC derivatives alone can take multiple forms. Added to that, there
are repo and securities lending agreements and a new set of impending documents for OTC clearing reforms.
Agreements might have been drafted hastily, hand-typed, marked-up in pen and amended to include patchy coverage of provisions that have become increasingly relevant in the current economic climate. All of this was often scanned into PDF format and filed
in a bank’s legal department repositories. Many legal documentation solutions were inadequate and information was typed manually into in-house systems.
With the crisis, senior management across the front office, treasury, risk management, collateral management and legal departments began to dig deeper into the exact contents and meanings of these contracts. As a result, they unearthed the extent to which
document indexing, data capture and analytics had been overlooked and were confronted with the daunting task of piecing it all together.
One response was to write large cheques to the top law firms, which they sent along with the masses of original contracts, in search of a quick answer. In return, banks received a ‘million dollar spreadsheet’. The problem is that these contained the single
answer to a single question so became redundant when the next issue appeared.
If banks are to tackle this legacy and build a foundation to support ongoing OTC activity, they clearly need a new approach – and that approach has to be one of centralisation, automation and, crucially, accountability.