Dawning of a new era
12 July
Traditional collateral management functions are evolving into a collateral and liquidity trading business, says Bimal Kadikar of Transcend Street Solutions
Image: Shutterstock
The securities finance industry is going through a major evolution, driven primarily by regulatory and economic forces. A vast amount of literature and research has been published about the size and impact of these forces, and they are finally beginning to take shape. These changes are causing an increase in the demand of collateral and, at the same time, decrease in supply of high quality collateral. It is important to use collateral strategically, as a misaligned source and use of collateral may result in a significant capital impact due to liquidity coverage ratio (LCR) regulations. These dynamics are changing some of the most well established principles in the industry and creating some unique opportunities.
It is clear that this transition has already begun and many firms, either individually or with the help of consulting advisers, are busy identifying the appropriate target operating model. This operating model needs to address some critical questions and considerations. Given the significant rise of collateral requirement for initial and variation margin for cleared and uncleared businesses, it is imperative that collateral needs to be optimised. Should margin operations take on the challenge of optimisation or do they need to leverage front-office expertise to manage this process? Regardless of the operating model of choice, it is clear that securities lending and repo businesses will need to have a much tighter coordination with OTC and other margin operations functions.
Similarly, how should equities and fixed income funding businesses manage liquidity and coordinate with treasury and regulatory functions? New liquidity regulations such as the LCR and net stable funding ratio (NSFR) are very specific about how they treat various sources and uses and their term structure of liquidity in capital calculations. If these functions did not coordinate liquidity management and analytics, they would have significant punitive impact on capital.
In addition, new regulatory guidelines from recovery and resolution planning such as SR 14-1 also mandate specific capabilities for collateral and liquidity management. So, collateral and liquidity can no longer be managed in silos and firms need to have a broader and more comprehensive approach.
This sentiment is echoed in various industry conferences and events and most will agree that securities lending, repo trading, and traditional collateral management functions are evolving into a ‘collateral and liquidity trading’ function. Many firms are making organisational changes to support this evolution. Some firms have made ambitious moves and created one large organisation that manages all collateral and liquidity trading activities under one unit, whereas others have taken baby steps to make progress in this direction. This will probably go on for some time before it settles into a consistent organisation construct across the industry.
Organisational changes start to align incentives and priorities, but the key challenge is to align business, operational and technology capabilities across business silos to take advantage of the new organisation structure. Just like any other major change in the industry, there will be winners and there will be losers. It is clear that firms that embrace this change and adopt a strategic approach in managing their collateral and liquidity trading from business, technology, and operations perspective will have an edge over competition.
Currently, most firms have dedicated technology and operational capabilities for specific silos such as securities lending, repos, margin operations, treasury, and regulatory areas. There is some coordination of data and analytics across silos, but for the most part they operate on their own individual platforms. This is a huge challenge for firms to figure out how to develop a business and technology architecture for the new paradigm.
Some firms look for specific connectivity that needs to be built across units and address those requirements as per business priorities and pressures. This may seem like a practical approach but the key challenge is that, over time, firms will end up with a chaotic architecture that will be very difficult to manage, maintain, and modify.
In a slightly different approach, some firms are looking to identity an existing system and make it as an anchor platform that can be used by other areas. This approach will end up with a better architecture but is very difficult to execute. The typical technology platform for this industry is at least a decade old, and the number of changes that need to be implemented can overwhelm the technology and project delivery capabilities. Most firms are not yet comfortable with the thought of an uber monolithic platform that can serve the need of all business units in a meaningful way.
However, there is an alternative. At Transcend Street, we have focused on developing a strategic approach and technology that is specifically designed to support businesses through this evolution. Our approach is a thoughtful integration of existing systems, while providing new capabilities through state of the art technology developed for the new paradigm. Our technology fits into an existing business enterprise and does not mandate any major retirement or reengineering efforts for current platforms. This enables firms to leverage their current investments for the purpose they serve, but also develop next-generation capabilities in a smart and more predictable manner.
We see a three step process in building next-generation collateral and liquidity data management to support requirements across business areas. The first step is to focus on the biggest challenge in this space—data. We have developed targeted business models of data focused on the new reality, but which also leverage some of the new generation technologies to ensure easy extension and flexibility. The main focus is harmonisation and integrity of the data such as collateral agreements, trades, positions, settlement ladders, margin and exposure data, reference data for securities, accounts, legal entities, market data, and so on.
The second part is analytics and decision support services that operate on this data. This is how data is turned into information. Decision support is where a collateral substitution or optimisation process can result in quantifiable cost savings or new opportunities.
The third, and most visible part, is the rich user dashboards. Our dashboards bring information to users in a business friendly and actionable way. In addition, allowing users to control how decision support services should operate really drives the evolution of data into information and then into action. Our main goal is to provide a powerful technology platform and give users control via our dashboards.
This approach, coupled with next generation functional capabilities provided by CoSMOS, unlocks a massive opportunity for firms as they navigate through this evolution. CoSMOS provides several functional modules
Agreement Insight: This module allows firms to bring various collateral agreements together and harmonises them such that they can be evaluated consistently across business areas. Agreement Insight can connect to repositories of agreement data, external third parties such as triparty agents, as well as allow agreements to be captured and managed on the system. This module provides a key capability in meeting SR 14-1 compliance requirements for agreements.
Real-time Inventory/Position Management: CoSMOS connects to internal systems in front and back offices. It also has external settlement platforms to provide a real-time view of inventory as well as collateral across the enterprise with detailed traceability of transactions. This module allows users to identify exact collateral location, its liquidity and trading profile, ownership, and pace of movement through settlement ladders—all in real-time. This module is a critical component of the SR 14-1 requirement for visibility of collateral across the firm.
Margin Dashboard: Most firms have multiple margin centre such as over-the-counter (OTC) derivatives and repos. These margin centre can be a significant source and/or users of collateral in the firm and in most places they are buried in back-office infrastructure. CoSMOS margin dashboard connects operational margin infrastructure to the front-office collateral traders to plan and execute optimal collateral decisions.
Collateral Optimisation: The CoSMOS optimisation module provides the ability for businesses to optimally allocate collateral across businesses and functions. Sophisticated optimisation algorithms allow firms to leverage unique solutions from CoSMOS for optimisation decisions. Optimiser is then integrated with the appropriate processing platforms for straight-through operational capabilities. Firms also have flexibility to choose their own algorithms and integrate with the platform to leverage and the rest of data, analytics and straight-through processing capabilities.
Liquidity Analytics: CoSMOS provides many ways to manage and measure liquidity analytics across the firm. A sophisticated and rules-based sources-and-uses engine is a critical backbone for many functions such as cost of funds, client profitability, term structure of funding, to name a few. This engine can be customised for firm-wide or business specific scope and can also provide a ‘what if’ scenario for firms to evaluate new client or firm portfolio and its impact on liquidity profile. Other metrics include client portfolio trends as well as triparty allocation efficiency analysis and planning. In addition, CoSMOS provides an easy and extendable architecture to build new metrics and dashboards very quickly for user reviews and adoptions.
These are exciting times as economic environment, regulatory pressures and technological advances are creating entirely new opportunities for the industry. This is a big change and, like any large scale change, it needs to be navigated carefully. There will inevitably be winners and losers, but we strongly believe that an enterprise-wide collateral and liquidity management function to drive optimisation of cost and capital is a key differentiator in the new era. We will see a lot more integration and automation in the coming years across securities lending, repo, treasury, OTC derivatives and operations areas, and their silo-based systems will come under a lot of stress. Firms that embrace this change smartly and focus on developing a strategic operating environment with a sharp focus on execution will be clear winners.
It is clear that this transition has already begun and many firms, either individually or with the help of consulting advisers, are busy identifying the appropriate target operating model. This operating model needs to address some critical questions and considerations. Given the significant rise of collateral requirement for initial and variation margin for cleared and uncleared businesses, it is imperative that collateral needs to be optimised. Should margin operations take on the challenge of optimisation or do they need to leverage front-office expertise to manage this process? Regardless of the operating model of choice, it is clear that securities lending and repo businesses will need to have a much tighter coordination with OTC and other margin operations functions.
Similarly, how should equities and fixed income funding businesses manage liquidity and coordinate with treasury and regulatory functions? New liquidity regulations such as the LCR and net stable funding ratio (NSFR) are very specific about how they treat various sources and uses and their term structure of liquidity in capital calculations. If these functions did not coordinate liquidity management and analytics, they would have significant punitive impact on capital.
In addition, new regulatory guidelines from recovery and resolution planning such as SR 14-1 also mandate specific capabilities for collateral and liquidity management. So, collateral and liquidity can no longer be managed in silos and firms need to have a broader and more comprehensive approach.
This sentiment is echoed in various industry conferences and events and most will agree that securities lending, repo trading, and traditional collateral management functions are evolving into a ‘collateral and liquidity trading’ function. Many firms are making organisational changes to support this evolution. Some firms have made ambitious moves and created one large organisation that manages all collateral and liquidity trading activities under one unit, whereas others have taken baby steps to make progress in this direction. This will probably go on for some time before it settles into a consistent organisation construct across the industry.
Organisational changes start to align incentives and priorities, but the key challenge is to align business, operational and technology capabilities across business silos to take advantage of the new organisation structure. Just like any other major change in the industry, there will be winners and there will be losers. It is clear that firms that embrace this change and adopt a strategic approach in managing their collateral and liquidity trading from business, technology, and operations perspective will have an edge over competition.
Currently, most firms have dedicated technology and operational capabilities for specific silos such as securities lending, repos, margin operations, treasury, and regulatory areas. There is some coordination of data and analytics across silos, but for the most part they operate on their own individual platforms. This is a huge challenge for firms to figure out how to develop a business and technology architecture for the new paradigm.
Some firms look for specific connectivity that needs to be built across units and address those requirements as per business priorities and pressures. This may seem like a practical approach but the key challenge is that, over time, firms will end up with a chaotic architecture that will be very difficult to manage, maintain, and modify.
In a slightly different approach, some firms are looking to identity an existing system and make it as an anchor platform that can be used by other areas. This approach will end up with a better architecture but is very difficult to execute. The typical technology platform for this industry is at least a decade old, and the number of changes that need to be implemented can overwhelm the technology and project delivery capabilities. Most firms are not yet comfortable with the thought of an uber monolithic platform that can serve the need of all business units in a meaningful way.
However, there is an alternative. At Transcend Street, we have focused on developing a strategic approach and technology that is specifically designed to support businesses through this evolution. Our approach is a thoughtful integration of existing systems, while providing new capabilities through state of the art technology developed for the new paradigm. Our technology fits into an existing business enterprise and does not mandate any major retirement or reengineering efforts for current platforms. This enables firms to leverage their current investments for the purpose they serve, but also develop next-generation capabilities in a smart and more predictable manner.
We see a three step process in building next-generation collateral and liquidity data management to support requirements across business areas. The first step is to focus on the biggest challenge in this space—data. We have developed targeted business models of data focused on the new reality, but which also leverage some of the new generation technologies to ensure easy extension and flexibility. The main focus is harmonisation and integrity of the data such as collateral agreements, trades, positions, settlement ladders, margin and exposure data, reference data for securities, accounts, legal entities, market data, and so on.
The second part is analytics and decision support services that operate on this data. This is how data is turned into information. Decision support is where a collateral substitution or optimisation process can result in quantifiable cost savings or new opportunities.
The third, and most visible part, is the rich user dashboards. Our dashboards bring information to users in a business friendly and actionable way. In addition, allowing users to control how decision support services should operate really drives the evolution of data into information and then into action. Our main goal is to provide a powerful technology platform and give users control via our dashboards.
This approach, coupled with next generation functional capabilities provided by CoSMOS, unlocks a massive opportunity for firms as they navigate through this evolution. CoSMOS provides several functional modules
Agreement Insight: This module allows firms to bring various collateral agreements together and harmonises them such that they can be evaluated consistently across business areas. Agreement Insight can connect to repositories of agreement data, external third parties such as triparty agents, as well as allow agreements to be captured and managed on the system. This module provides a key capability in meeting SR 14-1 compliance requirements for agreements.
Real-time Inventory/Position Management: CoSMOS connects to internal systems in front and back offices. It also has external settlement platforms to provide a real-time view of inventory as well as collateral across the enterprise with detailed traceability of transactions. This module allows users to identify exact collateral location, its liquidity and trading profile, ownership, and pace of movement through settlement ladders—all in real-time. This module is a critical component of the SR 14-1 requirement for visibility of collateral across the firm.
Margin Dashboard: Most firms have multiple margin centre such as over-the-counter (OTC) derivatives and repos. These margin centre can be a significant source and/or users of collateral in the firm and in most places they are buried in back-office infrastructure. CoSMOS margin dashboard connects operational margin infrastructure to the front-office collateral traders to plan and execute optimal collateral decisions.
Collateral Optimisation: The CoSMOS optimisation module provides the ability for businesses to optimally allocate collateral across businesses and functions. Sophisticated optimisation algorithms allow firms to leverage unique solutions from CoSMOS for optimisation decisions. Optimiser is then integrated with the appropriate processing platforms for straight-through operational capabilities. Firms also have flexibility to choose their own algorithms and integrate with the platform to leverage and the rest of data, analytics and straight-through processing capabilities.
Liquidity Analytics: CoSMOS provides many ways to manage and measure liquidity analytics across the firm. A sophisticated and rules-based sources-and-uses engine is a critical backbone for many functions such as cost of funds, client profitability, term structure of funding, to name a few. This engine can be customised for firm-wide or business specific scope and can also provide a ‘what if’ scenario for firms to evaluate new client or firm portfolio and its impact on liquidity profile. Other metrics include client portfolio trends as well as triparty allocation efficiency analysis and planning. In addition, CoSMOS provides an easy and extendable architecture to build new metrics and dashboards very quickly for user reviews and adoptions.
These are exciting times as economic environment, regulatory pressures and technological advances are creating entirely new opportunities for the industry. This is a big change and, like any large scale change, it needs to be navigated carefully. There will inevitably be winners and losers, but we strongly believe that an enterprise-wide collateral and liquidity management function to drive optimisation of cost and capital is a key differentiator in the new era. We will see a lot more integration and automation in the coming years across securities lending, repo, treasury, OTC derivatives and operations areas, and their silo-based systems will come under a lot of stress. Firms that embrace this change smartly and focus on developing a strategic operating environment with a sharp focus on execution will be clear winners.
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