Collateral optimisation and the buyside

Many firms continue to wrestle with the requirements of the European Market Infrastructure Regulation (EMIR) trade reporting mandate. However, although the reporting requirements have been a challenge for most, there is evidence to suggest that an increasing number of buyside firms have fully resolved the operational EMIR connectivity challenges and are shifting their attention towards reaping the commercial benefits associated with collateral optimisation.  

A number of buyside firms claim that they are currently receiving significant benefits from their collateral optimisation process. The absolute size of the benefits is obviously dependent on the value of the firm’s collateral assets. With greater levels of operational sophistication, greater levels of operational saving can be achieved. However, as in all optimisation processes, there is a balance to be struck between the cost of implementing  / running the optimisation process and the benefits that it will bring. Inevitably there are diminishing returns as the process becomes more sophisticated, however, for the larger players the optimisation returns are significant. Yes, the process may be challenging, but the economic rewards are certainly there. Interestingly, evidence is now beginning to emerge in support of the view that the operational costs of buyside firms could potentially be covered by the savings realised through implementing a reasonably sophisticated collateral optimisation capability.  

The experience of firms in the early stages of investigating a collateral optimisation solution is normally illustrated by the firm looking for a complete solution, a ‘golden bullet’ or the simple flick of a switch that will generate  flawless optimisation. In reality the solution engaged by most (if not all) firms successfully employing an optimisation solution is an ongoing, iterative change process with step events resulting in incremental improvements in the firm’s optimisation process. Each step building on the last with ever increasing levels of complexity, improving total returns but with reducing incremental commercial benefits.

There is no single formula to be applied to the collateral optimisation solution. Every firm is different, simply because of differences in volumes, asset profiles, collateral management needs, systems and business drivers. However, the principles employed by most firms implementing an optimisation process are the same:    

Identify the assets: Often this requires developing a genuine view of a ‘single inventory’ of collateral (for each underlying legal trading entity).  Without such a view, collateral allocation cannot be optimised.

Liabilities: Liabilities arise in multiple places, for example; calls from central counterparties (CCPs) to cover exchange traded and OTC derivatives; margin calls from bilateral counterparts for uncleared trades; and from business lines such as repo, stock / borrow loan, etc. In order to optimise collateral usage, all liabilities must be accessible centrally.

Optimisation engine: In order to achieve collateral optimisation, firms must have a central ‘engine’ that can work with asset and liability data to generate proposed asset allocations, along with the associated security movements, costs, and benefits. Increasingly this data is required on a real (or near real) time basis.

Supporting data: The optimisation engine will require access to several additional data types, including pricing (interest and repo rates, haircuts etc.), and optimisation constraints (eligibility rules, CSA data, substitution rights and frequencies, corporate action events etc.).

The practical application of these principles is complex, with technical and organisational challenges that require full trade transparency across front and back office functions. Additionally, they require considerable technology input and market expertise. An increasing number of institutions are grasping these challenges and are illustrating that there are real benefits to be achieved by buyside institutions focusing on optimising their collateral processes.

The benefits of collateral optimisation offer a clear and tangible incentive for those firms who are still struggling with the requirements of the trade reporting mandate to hastily resolve their issues. As their competitors strive for and attain collateral optimisation, there is a real risk that firms who fail to do so will become less competitive  in the new regulatory environment.