Collateral Panel
30 April 2024
Securities finance specialists reflect on the transformation of collateral management, from an auxiliary service to a pivotal aspect of the ecosystem, and how the practice is being impacted by key regulatory initiatives
Image: stock.adobe/tongpatong
Panellists
David Beatrix, Head of OTC and Collateral Services, Securities Services, BNP Paribas
Jérôme Blais, Co-Head of Triparty Collateral Management, Securities Services, BNP Paribas
Darren Crowther, Head of Securities Finance and Collateral Management Solutions, Broadridge
Sam Edwards, Head of Alpha Collateral Services, EMEA and APAC, State Street
Charles Engle, Executive Director, Tri-party and Collateral Management, J.P. Morgan
Sabine Farhat, Head of Securities Finance, Product Management, Murex
Neil Murphy, Business Manager, triResolve Margin, OSTTRA
How has collateral management transformed from being viewed as an auxiliary service to becoming a pivotal aspect of the securities finance ecosystem?
Jérôme Blais: Collateral management has moved from being an almost purely operational concern to being part of the front office strategic decision making process. Firms can no longer afford to treat it with mere collateral operators, but now need to invest in people and a web of systems that can seamlessly manage collateral allocation across their trading activities.
In times of collateral rarefaction, smart and effective collateral management processes allow firms to be able to seize trading opportunities by making the most of their available balance sheet.
Despite the industry’s best efforts to create bridges between collateral pools, and make collateral venues more interoperable, front office collateral managers still need, more than ever, to build and operate models that allow them to mobilise collateral that is still moving across these venues on an almost constant basis. The move to T+1 will, more likely than not, put even more emphasis on the necessity to incorporate collateral management into the trading engine of most top-tier firms.
Sam Edwards: Collateral plays a key role in the facilitation of activity in the securities financing ecosystem. Its traditional role as a hedge against counterparty credit risk is well established. In recent years, especially the periods following stressed market conditions, collateral has become an indispensable tool in financing and liquidity management.
Movement in the value of collateral during the term of the transaction provides opportunities for dynamic valuation, and presents opportunities to derive economic benefits, as well as enhancing its traditional role in times of extreme market volatility. It also provides market participants with a reliable source of funding. Collateral can be deployed in two modes.
When collateral is an outright transfer of legal title, as in the case of securities financing transactions, it gives opportunities to the collateral receiver to redeploy it for its own financial activities. Where collateral is pledged and its re-use or rehypothecation is not permitted, as in the case of the Uncleared Margin Rules (UMR), it can be recalled and substituted by the collateral giver. Economic benefits of active collateral management have transformed its importance in equal measure across regulators and market participants.
Furthermore, the current interest rate environment has diminished the attractiveness of cash collateral. As the receiver of cash collateral benefits from reinvesting it. However, some part of the proceeds of reinvestment is rebated back to the collateral giver. With no clear indication on where the interest rate markets are headed, non-cash collateral is starting to replace cash. Collateralisation is a mainstay of financial markets with continuing demand, it has pivoted sharply from an auxiliary service to being a facilitator and enabler of financing transactions for all market participants.
Darren Crowther: Collateral Management has always been core to securities finance since it is an inherently collateralised form of trading. However, the impact of regulation has meant greater attention needs to be paid to the types of collateral accepted. These include factors such as the liquidity of the collateral and the market risk attached to them. Simply having a high credit rating is not enough for assessing the acceptability of collateral these days. Even high quality government bonds have seen increased levels of volatility since interest rates started to rise.
Sabine Farhat: Collateral management and securities finance are always interlinked. Historically, however, they were run by two siloed teams. The successive waves of regulations post crisis — Basel, UMR, T+1 and US Treasury repo clearing, to name a few — have created a unique challenge to collateral management. While the demand for high quality collateral is rising, its availability is suppressed due to capital and liquidity constraints. This mismatch underscores the necessity for increased collateral mobility within the securities finance market.
Meanwhile, market headwinds compel financial institutions to optimise asset usage, explore new revenue streams, and improve operational efficiencies. Adopting a holistic approach to collateral management and securities finance empowers firms to effectively manage inventory and liquidity to reduce funding costs, enhance yield and ensure regulatory compliance. This convergence also leads to optimised operations — it breaks silos and streamlines fragmented and manual processes.
Charles Engle: Collateral management has undergone a profound evolution, transitioning from its former perception as an ancillary service, to assuming a central role within the securities finance ecosystem. This shift is primarily attributed to the multifaceted utilisation of collateral beyond conventional securities financing activities. The expansion of collateral providers and receivers, coupled with the escalating growth in collateral obligations and balances, underscores the pivotal significance of collateral management. Moreover, the triparty infrastructure has been instrumental in facilitating this transformation, offering a robust framework for innovative applications of collateral.
Beyond traditional financing endeavours, collateral management now encompasses diverse functions such as managing uncleared initial margin (IM) for OTC derivatives, administering IM for central counterparties (CCPs), handling variation margin (VM) for OTC derivatives, facilitating structured financing arrangements, and optimising enterprise-wide collateral utilisation.
These versatile applications not only enhance risk mitigation but also unlock liquidity and mobilise assets across the securities finance landscape. Consequently, collateral management has emerged as a linchpin in fostering efficiency, resilience, alpha generation, cost savings, and liquidity within the securities finance ecosystem, marking a fundamental paradigm shift in its strategic importance.
What significant changes in collateral management practices have been observed since the global financial crisis of 2008, and how have these adaptations improved the resilience of the financial market?
David Beatrix: The changes have been massive. Firstly from a regulatory standpoint for OTC derivatives with the introduction of mandatory central clearing, then Uncleared Margin rules (variation and initial margins), or FINRA 4210 for the To-Be-Announced (TBA) market. Collateral is now a parameter fully integrated in the pricing of derivatives, and XVA desks are fully reliant on collateral parameters.
From an operations standpoint, the implicit problem was to cope with a complex landscape, while maximising efficiency with the smallest operational risk possible. There have been many initiatives of standardisation like the Clearing Connectivity Standard, and promotion of electronic platforms between participants to negotiate agreements, exchange data, agree margin calls etc. Some of them emerged as key for the overall resilience of collateral exchanges. The International Swaps and Derivatives Association (ISDA) is leading the data standardisation effort, jointly with the International Securities Lending Association (ISLA) and the European Repo Council (ERC), with the Common Domain Model initiative aiming to facilitate systems interoperably across different assets (derivatives, repo, securities lending).
From a liquidity perspective however, certain areas of the market are still facing challenges when it comes to mobilisation of liquidity, which triggered ‘dash for cash’ scenarios like in 2022 with the UK gilt crisis, which attracted the attention of regulators. The industry is not finished with regulations, with the possible introduction of US Treasury repo clearing in 2026, which will likely bring its own challenges to the repo market.
Farhat: The financial crisis and resulting regulations have fundamentally transformed how institutions manage collateral. This transformation has three key aspects:
Centralised collateral management — firms are now consolidating collateral management across different business units in order to bring transparency, meet increased margin pressures, unlock unused inventory, improve liquidity access and strengthen risk management practices. This enhances collateral mobility and increases liquidity in the whole market.
Rise of collateral utilities — centralised counterparty clearing houses (CCPs) and triparty services are becoming increasingly common. These utilities mitigate counterparty risk and reduce operational risks and costs. They contribute to a more stable financial system.
Standardisation, automation and electronification — the industry is moving toward greater standardisation, automation and electronic processes. Market participants are able to manage collateral more effectively by reducing legal and operational costs, ultimately leading to a more robust, transparent and efficient financial market.
Neil Murphy: The introduction of new global margin rules since 2016 has concentrated the attention of front office and collateral managers alike. For some, the focus has been narrow, with firms prioritising delivery against new IM requirements only (calculation, exchange and segregation of IM). In contrast, other firms have taken the opportunity to review their entire front-to-back margin process.
The distinction being, that these latter firms have been able to transform processes for VM, as well as IM, and in some cases have leveraged these synergies to support and improve processing for additional asset classes — including cleared, repo and exchange traded derivatives (ETD). These changes have been characterised by a move towards increased use of industry standards — such as reconciliation, calculation and documentation — and a wider adoption of automation and straight-through processing (STP), such as with electronic messaging and SWIFT.
Engle: Due to the evolving regulatory landscape and increased collateral demand since 2008, significant changes have reshaped collateral management practices, enhancing the resilience of the financial market. Notably, there has been a marked shift towards centralised data strategy, as well as automation and optimisation across various aspects of collateral management.
Centralised collateral data strategy has become the focus for sell and buy side firms across multiple dimensions, including instrument and market data, agreement and collateral eligibility, positions and transactions, and trade or collateral obligations. A siloed approach could work for individual businesses or desks, but treasurers and financial resource managers will be challenged in identifying and executing on optimisation opportunities or, more importantly, meeting regulatory requirements as regulators continue to focus on collateral as part of resolution planning, liquidity stress testing and other areas where firm-wide collateral data is critical.
The increased regulatory requirements and collateral demand has also been driving the need for holistic, scalable solutions. This includes the automation of repo processes, exemplified by the expansion of triparty programmes to support diverse trade activities and the introduction of new functionalities like real-time instruction management and workflow automation. Additionally, J.P. Morgan has expanded its triparty collateral management reach to include the buy side, with buy side firms increasingly relying on holistic solutions provided by custodians and collateral agents to navigate uncleared margin rules.
Moreover, the evolution and regulation of fully paid lending programmes has necessitated scalable and compliant collateral operating models, with a focus on safeguarding collateral through third-party custodians. These adaptations, to name a few, have bolstered the efficiency, transparency, and risk management capabilities of collateral management practices, contributing to the overall resilience of the financial market. Through automation, enhanced connectivity, compliance measures, and the surrounding data strategy, collateral management has played a crucial role in mitigating systemic risks and strengthening the robustness of the financial ecosystem in the post-crisis landscape.
Crowther: There has been a combination of initiatives that were already in progress before the global financial crisis, but were accelerated by it, as well as those that were driven by the wave of regulation that followed the crisis.
Greater consolidation of collateral management functions and technology across asset classes began before the global financial crisis, but has been sped up due to the challenges associated with obtaining a consolidated view of counterparty risk. The consensus is that increased use of clearing, standardisation of IM, standardisation of risk-weighted asset (RWA) calculations, standardisation of CSAs, processes, the Common Domain Model (CDM), and automation, along with a more holistic approach to collateral management, have contributed to enhanced resilience.
However, many firms have struggled with integrating collateral management across asset classes and legal entities. They have been held back by a combination of issues. These include technology, divergent practices between asset classes, organisational structure, and static data.
Edwards: In a bid to match the demand created by regulatory reforms, key standards and operational practices have been implemented across the globe to standardise the legal and operational frameworks underpinning collateral management. A key impediment to efficient use of collateral is lack of visibility and mobilisation in a timely and cost effective manner. In addition, standard eligibility criteria and haircuts have also been adopted to reduce friction regarding valuation and eligibility schedules.
Collateral transformation or ‘upgrades’ have become instrumental in easing the pressure on high-quality collateral. Typically, equities or corporate bonds do not meet all of the eligibility criteria of regulatory standards. These securities can be transformed to eligible collateral through repo or securities lending transactions.
In the same period, operational processes have improved across the board. In the decade before the financial crisis, more often than not, collateral management was back office activity which usually ran on spreadsheets. Exposures were frequently over collateralised to avoid daily movement of collateral between counterparties, particularly in the OTC markets. In the last decade, medium to large size firms have established robust technology and processes to manage end-to-end collateral flows. In addition, the industry has established best operational practices and benchmarks to enable standardisation and effective use of technology.
Can you discuss the evolving role of collateral diversification and its impact on the collateral management landscape?
Crowther: For years following the global financial crisis, central banks were accumulating various high-quality collateral as part of their quantitative easing policies. There was also an increased use of cash due to significantly lower interest rates. We also saw greater use of cash because of the much lower interest rates. As interest rates have increased and we have seen quantitative easing, the range of collateral available has increased and opportunity costs of different types have changed.
However, the primary driver of collateral diversification has come from the realisation that it is not just about the credit quality of issuers — it is about the market risk attached to different securities. The UK LDI crisis serves as a striking example of this shift, along with significant price fluctuations in various long-dated high quality government bonds.
Murphy: The combination of rising interest rates and new regulations have seen firms expand the types of collateral they pledge, requiring many to exchange non-cash collateral for the first time. For those with some prior experience in using these assets (for example where they have a sizeable repo or cleared book) the change has been simpler and has been more about increasing funding only. However, for others, the broadening of assets has required wider changes to systems; documentation and onboarding with triparty agents; connectivity to market infrastructure (SWIFT) etc. In turn, this diversification also increases the focus on collateral funding, leading firms to prioritise collateral optimisation as a way to minimise overall costs.
Edwards: Regulatory obligations have created a tight market for high-quality liquid assets (HQLA). Assets are considered HQLA if they are liquid and maintain their value in stress conditions. Another measure of liquidity is through the ease of sale or repo of the asset. Collateral diversification is key to mitigating market risk. Overexposure to a borrower, currency, sector, or asset class, creates concentration risk. Collateral’s ultimate goal is to protect the non-defaulting counterparty. In the event of counterparty default or market event, diversification helps to reduce liquidation costs for concentrated pools of collateral.
On the other hand, a less diversified pool may prove challenging to liquidate, or may need to be substantially discounted to liquidate. However, achieving diversity is not easy. It requires ongoing monitoring and review of collateral valuations, and making necessary adjustments to the pool. Operationally, the legal entity, physical locations of collateral and supporting market infrastructure are important elements in diversification considerations.
In addition, an important factor in driving changes in eligible collateral schedules (ECS) is the changing rates and profit margin environments. As lenders search for increased yield, their risk appetite has broadened during periods of low rates and stable markets, while the re-introduction of risk to the market over the past five years has led to a retrenchment of this approach as returns increased and risk aversion returned.
Engle: Collateral diversification plays a pivotal role in shaping the collateral management landscape, fostering resilience and enhancing market efficiency. As financial markets evolve, institutions seek to broaden their collateral horizons, tapping into new markets and asset classes to optimise their financing and derivatives activities. This shift towards diversification is exemplified by initiatives like J.P. Morgan Tri-party's expansion into new markets (eg Poland) and within existing markets (eg Japan, China Stock Connect, Korea, Taiwan), enabling clients to leverage a wider array of assets for collateral purposes.
By embracing diverse collateral options, institutions mitigate concentration risk, enhance liquidity, and unlock new opportunities for asset mobilisation. Furthermore, collateral diversification promotes market stability by reducing reliance on specific asset types or regions, therefore bolstering the overall resilience of the financial system. As the demand for collateral diversification continues to grow, collaboration between market participants and innovative solutions will further shape the collateral management landscape, ensuring its adaptability to evolving market dynamics.
Farhat: Traditionally, cash and government bonds are major forms of collateral. However, post-crisis regulations and challenging market dynamics increase collateral scarcity, liquidity pressure and concentration risk. To explore alternative, acceptable forms of collateral, optimise capital and liquidity, enhance returns and mitigate risk, firms tap more and more into a wider pool of collateral, including equities, corporate bonds or even alternative assets such as commodities, digital assets and structured products.
This brings several challenges to collateral management. First, managing a broad range of collateral requires robust processes to assess and represent asset eligibility in the collateral schedule, value collateral accurately and efficiently handle margin calls.
Second, it multiplies monitoring and optimisation of global collateral inventory complexity. Third, diversifying collateral holdings might also introduce more counterparty risk, which requires careful valuation and management. To cope with these challenges, the collateral management industry demands sophisticated systems capable of evaluating, monitoring and processing wide and evolving types of collateral in a centralised framework.
How do regulatory initiatives such as accelerated settlement and central clearing affect collateral management practices, and what measures are firms taking to enhance efficiency in compliance with these standards?
Edwards: The move to T+1 in the US and the upcoming changes to US Treasury clearing are continuing to drive the move towards automated, STP-based collateral and inventory management solutions. Our clients are well positioned to further develop their optimisation capabilities, as the use of intelligent solutions and frictionless environments such as State Street triparty enable the next level of alpha generation for their shareholders.
The disadvantage of this continued regulatory focus on transparency and risk reintermediation is that we will see costs increase for buy side firms in particular. The barriers to entry, along with the increase in liquidity buffer, and initial process friction, will not be appealing given the increased requirements placed on them in recent years, through requirements such as the UMR.
Farhat: Regulatory initiatives such as accelerated settlement and central clearing have profound effects on collateral management practices. A shortened settlement cycle requires firms to post collateral more quickly to fulfil transaction obligations. This places greater pressure to efficiently allocate and mobilise collateral in a timely manner. Mandates for the central clearing of derivatives, and soon, US Treasury and US Treasury repos, might increase margin requirements due to an increase in clearing activity and margin segregation requirements. It also shifts collateral management responsibilities toward managing relationships with CCPs and ensuring compliance with their margin requirements.
To optimise collateral allocation and ensure compliance, firms are centralising collateral management functions to achieve better control and visibility across business lines. This is facilitated by adopting a multi-function and multi-asset system that natively integrates collateral management functions with trading, risk management and settlement. Firms are also investing in advanced technology and automation, to streamline collateral operations from margin calculation and margin call management down to settlement and regulatory reporting.
Engle: Regulatory initiatives such as accelerated settlement and central clearing significantly impact collateral management practices, prompting firms to adopt measures aimed at enhancing efficiency and compliance with these standards. The transition from a T+2 to a T+1 settlement cycle in the US, effective 28 May 2024, necessitates swift adjustments to systems and processes to mitigate settlement risk and enhance capital efficiency. Firms face challenges in re-prioritising initiatives to align with the accelerated timeline, particularly in securities lending programmes where recall time frames must be condensed and processes realigned to prevent settlement fails.
Borrowers and lending agents are urged to adapt their procedures to ensure timely recalls and collateral returns. Triparty agents offer a streamlined and highly STP solution for managing non-cash collateral, minimising the operational hurdles associated with bilateral management. Additionally, central clearing mandates, especially for derivatives, compel firms to optimise collateral usage and explore end-to-end solutions. Buy side firms are increasingly outsourcing collateral processing to leverage expertise and reduce operational risk.
Collaborating with collateral managers facilitates holistic management, allowing firms to focus on strategic objectives while ensuring compliance with regulatory standards. These measures underscore the industry's commitment to adaptability and efficiency amid evolving regulatory landscapes.
Beatrix: Many regulations have direct or indirect effects on collateral. Reducing settlement cycles for example, implies reduced substitution cycles, in cases like the sale of a posted asset, which makes the recall a bigger challenge especially under a bilateral collateral setup. Together with the introduction of the Central Securities Depositories Regulation (CSDR) and settlement fail penalties, the impacts for firms can be substantial.
On another point, central clearing implies that cash is king for VM, which is a challenge for structurally cash-poor institutions like pension schemes hedging their liabilities with cleared swaps, and whose clearing exemption ended in June 2023. They have to maintain a structural cash ladder based on adverse market scenarios, while still achieving yield and remain as invested as possible.
The IM rules introduced completely new processes, with a significant adoption of triparty and the particular aspects of threshold monitoring, implying the need for the front office to monitor their trading levels with each counterparty carefully.
Crowther: One of the major side effects of central clearing has been to enforce a high degree of standardisation around both trading and collateral practices. Additionally, margin calls from the CCP must be promptly collateralised, regardless of whether participants agree or dispute the values reported by the CCPs. Both of these factors help to reduce friction and inefficiency in collateral management, even though some may miss the previous flexibility.
The transfer of collateral, as well as securities finance transactions, typically settle more quickly than transactions in the cash securities markets. However, the challenge arises when providers of collateral need securities back quickly, in order to settle any sales they make of those securities. This can lead to an increase in fails. While there are markets that settle on T+1, or have no tolerance for fails, these are not always the largest markets. If reduced settlement cycles cause more friction, larger markets will need to adapt and learn from them.
How does triparty collateral management support the transition to central clearing, and what role does it play in enhancing liquidity and efficiency in the collateral market?
Engle: J.P. Morgan Tri-party collateral management facilitates the transition to central clearing by offering the CCP Margin Exchange (CCPMx) solution, enhancing liquidity and operational efficiency for clearing members. By aligning with CCPs' preference for bilateral collateral delivery, CCPMx combines Tri-party's optimisation and eligibility engines with bilateral market movements. This approach simplifies collateral delivery and return processes, including intraday recalls, while optimising collateral selection and reducing operational burdens. J.P. Morgan Tri-party's role extends to managing collateral against margin obligations across multiple CCPs, streamlining connectivity and providing clients with a consolidated view of global collateral obligations across their securities financing and derivatives collateral activity. Through partnerships like with Baton Systems (Core Collateral), J.P. Morgan has connectivity to major CCPs globally, further enhancing liquidity and efficiency in the collateral market while simplifying collateral management for market participants.
Farhat: Triparty collateral management (TCM) bridges traditional bilateral collateral and central clearing. It facilitates collateral segregation and movement to and from the CCP. When a market participant pledges collateral directly with a third-party agent, this collateral is segregated from other assets and can then be used to fulfil margin requirements for centrally cleared transactions. TCM also reduces operational burden and simplifies compliance with CCP for clearing members by automating collateral operations, centralising record keeping, and standardising documentations and processes.
TCM plays a vital role in enhancing liquidity and efficiency in the collateral market. It enables efficient allocation and utilisation of collateral assets across multiple transactions and counterparties, ensuring that collateral is available when and where it is needed most. This improves overall liquidity in the market, mitigates counterparty risk and increases market resilience. TCM also contributes to a more efficient collateral landscape by accelerating collateral movements, reducing errors and minimising processing costs via automation and streamlining.
Edwards: As a triparty service provider, and through our Collateral+ solution, evolving market regulation offers us the chance to enable enhanced technology solutions to our clients with a view to gaining more returns from their inventory, reducing overall capital requirements and gaining access to a greater diversity of liquidity sources. Triparty can play a key role in this, supported by the continuing development of the interoperability approach, by reducing physical settlement requirements and enabling ‘round the clock’ collateral mobility.
As our clients step up to driving value creation throughout the end-to-end trade cycle, State Street Triparty has a key role to play in both the traditional and digital landscape.
What role does technology, particularly AI and blockchain, play in innovating collateral management processes, and how can firms ensure successful integration and adoption of such technologies?
Crowther: Collateral still exists in silos and there are still the associated costs and frictions of managing collateral on a global basis. Broadridge has used DLT to help make it easier to mobilise collateral and is developing AI solutions that help deal with the frictions that occur in the post-trade processes.
Successful adoption and integration of technologies, such as artificial intelligence and blockchain, ultimately depend on being laser focused on the problem that needs to be Solved, as well as picking the right tool for the job. This is the approach Broadridge has taken, and it has helped to get our new products into production at multiple clients.
Murphy: The collateral management process has historically been resource-intensive, demanding significant time and financial investment for daily operations. Consequently, it stands to benefit greatly from technological advancements that can streamline processes, reduce costs, mitigate risks, and minimise manual intervention. Recent advancements in technology, particularly in margin call messaging and reconciliation, have centred around the adoption of standardised industry platforms, enhancing connectivity for all market participants.
To ensure widespread adoption, future innovations — including the adoption of AI and blockchain — should follow a similar approach. They should aim to minimise barriers to adoption, offer cost-effective solutions, and deliver clear and demonstrable benefits. Given the bilateral nature of collateral management, improvements must cater to firms of all sizes, not just the largest players, ensuring accessibility and usability across the industry.
Farhat: Technology, including AI and blockchain, is transforming collateral management by offering greater efficiency, cost reduction and risk mitigations. AI has the potential to automate decision making processes, such as collateral optimisation and risk management, and perform predictive analysis on future collateral requirements. Blockchain can enhance efficiency by improving transparency and traceability of collateral records, reducing intermediaries, and increasing liquidity and accessibility of collateral assets.
To ensure successful integration and adoption of such technologies, firms must invest in robust, scalable and modern infrastructure and technology platforms. These investments lay a solid foundation — they enable centralisation, automation and digitalisation, and allow firms to adapt swiftly to new technological advancements. Collaboration with technology vendors and industry partners is also crucial to facilitate the integration of technology innovations.
Engle: Technology, particularly AI and blockchain, is revolutionising collateral management processes by enabling optimisation, cost reduction, and asset mobilisation. AI aids in optimising collateral on a broader scale, while blockchain technology facilitates the tokenisation of assets, unlocking their value and streamlining their mobilisation. For instance, J.P. Morgan's Tokenized Collateral Network (TCN) leverages blockchain to enable near-instantaneous settlement of collateral transactions, enhancing liquidity and efficiency.
Tokenisation enables the release of ‘trapped’ assets and adds utility to — and removes mobility friction from — highly liquid assets. For example, BlackRock and Barclays used TCN to deliver money market fund (MMF) collateral for an OTC derivatives trade. This solution transformed the usage of an asset class that was nearly impossible to mobilise as collateral to a near-instantaneous transfer of MMFs at the time of the margin call.
Successful integration and adoption of these technologies require firms to prioritise interoperability, ensuring seamless connectivity with existing systems and platforms. Moreover, firms should invest in robust cybersecurity measures to safeguard sensitive data and build trust in these innovative solutions. Collaborating with industry partners and regulatory bodies can also facilitate standardisation and promote widespread adoption, driving further innovation in collateral management practices. By embracing cutting edge technologies and fostering collaboration, firms can navigate the evolving landscape of collateral management with agility and efficiency.
Edwards: The technology evolution is not slowing down, and all financial services firms are technology firms in one shape or form. The adoption of AI and distributed ledger technologies (DLT) is taking place in differing ways. While some firms have been looking at revolutionary approaches, at State Street, we see the best results coming through market alignment via evolutionary methods. The use case for DLTs to enhance collateral mobility and globalisation of domestic asset liquidity is clear. Combining this with our triparty platforms brings the next level of inventory efficiency for our clients.
While the initial process developments for AI are to enable greater responsiveness and effectiveness in resolution of the remaining manual processes in the collateral chain, such as enhanced dispute management and client reporting. An innovation mindset is key for us at State Street, as we help our clients to adapt to a landscape where the pace of change continues to accelerate.
How are firms addressing recent liquidity stresses in the market, and what innovative solutions are being offered to provide clients with greater flexibility in managing liquidity needs?
Edwards: Market stress events throughout 2020, 2021 and 2022, have caused market participants to think more carefully about their liquidity needs and associated management. Historically, many buy side market participants have fulfilled their collateral obligations by sourcing inventory against exposures on a like-for-like basis across accounts within the same legal entity, or by running cumbersome internal processes to aggregate inventory into one account to cover all exposures under that legal entity.
Increasingly, market participants are turning to robust optimisation engines to allow them to specify algorithmic rules for sourcing inventory across their account range into centralised collateral inventory accounts or long boxes. The inventory in these long boxes is then used to facilitate settlement against counterparty exposures according to client configured rules. Clients are able to configure the allocation of inventory from their accounts to the long boxes and from the long boxes to counterparties as best suits the needs of their trading relationships.
Settlement of inventory between client custody accounts, long boxes and counterparties, is automated by the optimisation engine to improve process efficiency. These solutions enable market participants to deploy inventory from multiple sources in the most optimal manner possible across their trading agreements, and allows them to improve the efficiency of their portfolios, reduce liquidity risk, and help facilitate the deployment of more inventory towards higher value activities.
Beatrix: The implied cost of collateral in derivatives pricing means that cash remains somehow king on the OTC market. In fact, there is no other option on centrally-cleared OTCs, while the latest ISDA surveys show that cash remains favoured on non-cleared OTCs — despite a slight decrease in the use of cash versus securities compared with two years ago.
Repo facilities can be an option to ease the sourcing of cash for cash-poor players, as these offer an option to source cash at a cost possibly cheaper than the funding cost implied in the derivatives price assuming securities collateral.
Besides, there have been moves recently to facilitate the eligibility of tokenised assets as collateral, such as the Tokenized Collateral Model Provisions in the ISDA Credit Support Annex (CSA), or the Luxembourg Blockchain III Law. However, the gains observed on tokenisation so far at proof-of-concept level are still limited, especially with regards to the collateral traps they could create versus the rest of the market (assuming adoption remains limited and DLT networks are not interoperable).
Blais: In times of collateral stress, one can look at utilising non-traditional pools of liquidity, such as assets traditionally held and kept in local markets, as a start.
Indeed, as some markets require segregated account structure, beneficial ownership records come with other local requirements that usually make it too difficult to use these assets as collateral in triparty. By exploring the ability to leverage domestic pools of collateral in segregated or emerging markets, firms can find alternative ways to bring additional supply into their global collateral inventory.
Another way to minimise the impact of liquidity stress is to ensure that collateral is mobilised with a near 100 per cent efficiency rate. To do so, either via triparty modules, or through their own models, trading firms should test collateral allocation and eligibility prior to moving inventory, and even before committing to trades. This allows front office collateral managers to anticipate funding needs, avoid collateral shortfalls when possible, and reduce operational costs by guaranteeing eligibility prior to committing collateral pools.
Engle: J.P. Morgan Tri-party has been working with clients on various innovative solutions that support greater flexibility in managing liquidity needs. One approach involves mobilising assets that are traditionally hard to finance or post as collateral. J.P. Morgan has been collaborating with triparty clients to support structured financing and unlock the value of assets like restricted shares, loans, and MMFs for financing activity. By leveraging J.P. Morgan Tri-party’s capabilities to un-trap and optimise assets, firms can realise the value of these assets to support overall market liquidity, and generate incremental returns while managing collateral to meet capital and other binding constraints.
J.P. Morgan Tri-party also continues to invest in enhanced inventory management capabilities including reuse, multisource longbox, triparty interoperability and collateral transport. Reuse, multisource longbox and triparty interoperability (J.P. Morgan Tri-party and Euroclear) enable clients to seamlessly move assets across global entities, counterparties and triparty agents (ie J.P. Morgan Tri-party and Euroclear) without the limitations of settlement friction or market cut-off times. Collateral Transport orchestrates asset mobilisation across custody, lending and triparty through the J.P. Morgan Agency Securities Finance platform, enabling assets to be transported swiftly between custodians and triparty agents for lending and fulfilling margin obligations.
By leveraging these innovative solutions, firms can adapt to changing market conditions and better meet their clients' liquidity needs with increased flexibility and efficiency.
Farhat: Firms are managing recent liquidity stresses through a multifaceted approach, which includes:
Diversification of payoffs and strategies. Financial institutions seek balance sheet optimisation by reducing capital charges or lowering funding costs. This can be achieved through new payoffs like evergreen and triparty trades, as well as alternative cash exchange strategies, such as synthetic repo, fully funded swaps, synthetic margin lending and margin loans.
Emergence of central funding units. Fixed income and equity desks are collaborating to optimise the firm-wide securities inventory, empowering traders to make informed decisions on cash and collateral allocation promptly.
Growth of agency lending and prime finance business. These activities enable banks to earn income on capital and generate returns on idle securities holdings, thereby strengthening their balance sheet and mitigating various risks.
To leverage these strategies, firms need advanced technology that offers a rich and evolving library of payoffs across assets, centralise inventory and liquidity management across the organisation, and streamline operations front-to-back-to-risk.
Crowther: For the last few years, there has been a trend towards converging operational cash management and liquidity management, typically performed by a trading desk or treasury. Market movements over the last year have accelerated this.
Periods of extreme market volatility drive more intraday margin calls by CCPs. That means greater need for intraday liquidity. Part of the solution provided by systems is the ability to have a more real-time view on liquidity. Another aspect is the creation of tools that support intraday funding. Broadridge, for example, has introduced tools that support intraday repo transactions.
David Beatrix, Head of OTC and Collateral Services, Securities Services, BNP Paribas
Jérôme Blais, Co-Head of Triparty Collateral Management, Securities Services, BNP Paribas
Darren Crowther, Head of Securities Finance and Collateral Management Solutions, Broadridge
Sam Edwards, Head of Alpha Collateral Services, EMEA and APAC, State Street
Charles Engle, Executive Director, Tri-party and Collateral Management, J.P. Morgan
Sabine Farhat, Head of Securities Finance, Product Management, Murex
Neil Murphy, Business Manager, triResolve Margin, OSTTRA
How has collateral management transformed from being viewed as an auxiliary service to becoming a pivotal aspect of the securities finance ecosystem?
Jérôme Blais: Collateral management has moved from being an almost purely operational concern to being part of the front office strategic decision making process. Firms can no longer afford to treat it with mere collateral operators, but now need to invest in people and a web of systems that can seamlessly manage collateral allocation across their trading activities.
In times of collateral rarefaction, smart and effective collateral management processes allow firms to be able to seize trading opportunities by making the most of their available balance sheet.
Despite the industry’s best efforts to create bridges between collateral pools, and make collateral venues more interoperable, front office collateral managers still need, more than ever, to build and operate models that allow them to mobilise collateral that is still moving across these venues on an almost constant basis. The move to T+1 will, more likely than not, put even more emphasis on the necessity to incorporate collateral management into the trading engine of most top-tier firms.
Sam Edwards: Collateral plays a key role in the facilitation of activity in the securities financing ecosystem. Its traditional role as a hedge against counterparty credit risk is well established. In recent years, especially the periods following stressed market conditions, collateral has become an indispensable tool in financing and liquidity management.
Movement in the value of collateral during the term of the transaction provides opportunities for dynamic valuation, and presents opportunities to derive economic benefits, as well as enhancing its traditional role in times of extreme market volatility. It also provides market participants with a reliable source of funding. Collateral can be deployed in two modes.
When collateral is an outright transfer of legal title, as in the case of securities financing transactions, it gives opportunities to the collateral receiver to redeploy it for its own financial activities. Where collateral is pledged and its re-use or rehypothecation is not permitted, as in the case of the Uncleared Margin Rules (UMR), it can be recalled and substituted by the collateral giver. Economic benefits of active collateral management have transformed its importance in equal measure across regulators and market participants.
Furthermore, the current interest rate environment has diminished the attractiveness of cash collateral. As the receiver of cash collateral benefits from reinvesting it. However, some part of the proceeds of reinvestment is rebated back to the collateral giver. With no clear indication on where the interest rate markets are headed, non-cash collateral is starting to replace cash. Collateralisation is a mainstay of financial markets with continuing demand, it has pivoted sharply from an auxiliary service to being a facilitator and enabler of financing transactions for all market participants.
Darren Crowther: Collateral Management has always been core to securities finance since it is an inherently collateralised form of trading. However, the impact of regulation has meant greater attention needs to be paid to the types of collateral accepted. These include factors such as the liquidity of the collateral and the market risk attached to them. Simply having a high credit rating is not enough for assessing the acceptability of collateral these days. Even high quality government bonds have seen increased levels of volatility since interest rates started to rise.
Sabine Farhat: Collateral management and securities finance are always interlinked. Historically, however, they were run by two siloed teams. The successive waves of regulations post crisis — Basel, UMR, T+1 and US Treasury repo clearing, to name a few — have created a unique challenge to collateral management. While the demand for high quality collateral is rising, its availability is suppressed due to capital and liquidity constraints. This mismatch underscores the necessity for increased collateral mobility within the securities finance market.
Meanwhile, market headwinds compel financial institutions to optimise asset usage, explore new revenue streams, and improve operational efficiencies. Adopting a holistic approach to collateral management and securities finance empowers firms to effectively manage inventory and liquidity to reduce funding costs, enhance yield and ensure regulatory compliance. This convergence also leads to optimised operations — it breaks silos and streamlines fragmented and manual processes.
Charles Engle: Collateral management has undergone a profound evolution, transitioning from its former perception as an ancillary service, to assuming a central role within the securities finance ecosystem. This shift is primarily attributed to the multifaceted utilisation of collateral beyond conventional securities financing activities. The expansion of collateral providers and receivers, coupled with the escalating growth in collateral obligations and balances, underscores the pivotal significance of collateral management. Moreover, the triparty infrastructure has been instrumental in facilitating this transformation, offering a robust framework for innovative applications of collateral.
Beyond traditional financing endeavours, collateral management now encompasses diverse functions such as managing uncleared initial margin (IM) for OTC derivatives, administering IM for central counterparties (CCPs), handling variation margin (VM) for OTC derivatives, facilitating structured financing arrangements, and optimising enterprise-wide collateral utilisation.
These versatile applications not only enhance risk mitigation but also unlock liquidity and mobilise assets across the securities finance landscape. Consequently, collateral management has emerged as a linchpin in fostering efficiency, resilience, alpha generation, cost savings, and liquidity within the securities finance ecosystem, marking a fundamental paradigm shift in its strategic importance.
What significant changes in collateral management practices have been observed since the global financial crisis of 2008, and how have these adaptations improved the resilience of the financial market?
David Beatrix: The changes have been massive. Firstly from a regulatory standpoint for OTC derivatives with the introduction of mandatory central clearing, then Uncleared Margin rules (variation and initial margins), or FINRA 4210 for the To-Be-Announced (TBA) market. Collateral is now a parameter fully integrated in the pricing of derivatives, and XVA desks are fully reliant on collateral parameters.
From an operations standpoint, the implicit problem was to cope with a complex landscape, while maximising efficiency with the smallest operational risk possible. There have been many initiatives of standardisation like the Clearing Connectivity Standard, and promotion of electronic platforms between participants to negotiate agreements, exchange data, agree margin calls etc. Some of them emerged as key for the overall resilience of collateral exchanges. The International Swaps and Derivatives Association (ISDA) is leading the data standardisation effort, jointly with the International Securities Lending Association (ISLA) and the European Repo Council (ERC), with the Common Domain Model initiative aiming to facilitate systems interoperably across different assets (derivatives, repo, securities lending).
From a liquidity perspective however, certain areas of the market are still facing challenges when it comes to mobilisation of liquidity, which triggered ‘dash for cash’ scenarios like in 2022 with the UK gilt crisis, which attracted the attention of regulators. The industry is not finished with regulations, with the possible introduction of US Treasury repo clearing in 2026, which will likely bring its own challenges to the repo market.
Farhat: The financial crisis and resulting regulations have fundamentally transformed how institutions manage collateral. This transformation has three key aspects:
Centralised collateral management — firms are now consolidating collateral management across different business units in order to bring transparency, meet increased margin pressures, unlock unused inventory, improve liquidity access and strengthen risk management practices. This enhances collateral mobility and increases liquidity in the whole market.
Rise of collateral utilities — centralised counterparty clearing houses (CCPs) and triparty services are becoming increasingly common. These utilities mitigate counterparty risk and reduce operational risks and costs. They contribute to a more stable financial system.
Standardisation, automation and electronification — the industry is moving toward greater standardisation, automation and electronic processes. Market participants are able to manage collateral more effectively by reducing legal and operational costs, ultimately leading to a more robust, transparent and efficient financial market.
Neil Murphy: The introduction of new global margin rules since 2016 has concentrated the attention of front office and collateral managers alike. For some, the focus has been narrow, with firms prioritising delivery against new IM requirements only (calculation, exchange and segregation of IM). In contrast, other firms have taken the opportunity to review their entire front-to-back margin process.
The distinction being, that these latter firms have been able to transform processes for VM, as well as IM, and in some cases have leveraged these synergies to support and improve processing for additional asset classes — including cleared, repo and exchange traded derivatives (ETD). These changes have been characterised by a move towards increased use of industry standards — such as reconciliation, calculation and documentation — and a wider adoption of automation and straight-through processing (STP), such as with electronic messaging and SWIFT.
Engle: Due to the evolving regulatory landscape and increased collateral demand since 2008, significant changes have reshaped collateral management practices, enhancing the resilience of the financial market. Notably, there has been a marked shift towards centralised data strategy, as well as automation and optimisation across various aspects of collateral management.
Centralised collateral data strategy has become the focus for sell and buy side firms across multiple dimensions, including instrument and market data, agreement and collateral eligibility, positions and transactions, and trade or collateral obligations. A siloed approach could work for individual businesses or desks, but treasurers and financial resource managers will be challenged in identifying and executing on optimisation opportunities or, more importantly, meeting regulatory requirements as regulators continue to focus on collateral as part of resolution planning, liquidity stress testing and other areas where firm-wide collateral data is critical.
The increased regulatory requirements and collateral demand has also been driving the need for holistic, scalable solutions. This includes the automation of repo processes, exemplified by the expansion of triparty programmes to support diverse trade activities and the introduction of new functionalities like real-time instruction management and workflow automation. Additionally, J.P. Morgan has expanded its triparty collateral management reach to include the buy side, with buy side firms increasingly relying on holistic solutions provided by custodians and collateral agents to navigate uncleared margin rules.
Moreover, the evolution and regulation of fully paid lending programmes has necessitated scalable and compliant collateral operating models, with a focus on safeguarding collateral through third-party custodians. These adaptations, to name a few, have bolstered the efficiency, transparency, and risk management capabilities of collateral management practices, contributing to the overall resilience of the financial market. Through automation, enhanced connectivity, compliance measures, and the surrounding data strategy, collateral management has played a crucial role in mitigating systemic risks and strengthening the robustness of the financial ecosystem in the post-crisis landscape.
Crowther: There has been a combination of initiatives that were already in progress before the global financial crisis, but were accelerated by it, as well as those that were driven by the wave of regulation that followed the crisis.
Greater consolidation of collateral management functions and technology across asset classes began before the global financial crisis, but has been sped up due to the challenges associated with obtaining a consolidated view of counterparty risk. The consensus is that increased use of clearing, standardisation of IM, standardisation of risk-weighted asset (RWA) calculations, standardisation of CSAs, processes, the Common Domain Model (CDM), and automation, along with a more holistic approach to collateral management, have contributed to enhanced resilience.
However, many firms have struggled with integrating collateral management across asset classes and legal entities. They have been held back by a combination of issues. These include technology, divergent practices between asset classes, organisational structure, and static data.
Edwards: In a bid to match the demand created by regulatory reforms, key standards and operational practices have been implemented across the globe to standardise the legal and operational frameworks underpinning collateral management. A key impediment to efficient use of collateral is lack of visibility and mobilisation in a timely and cost effective manner. In addition, standard eligibility criteria and haircuts have also been adopted to reduce friction regarding valuation and eligibility schedules.
Collateral transformation or ‘upgrades’ have become instrumental in easing the pressure on high-quality collateral. Typically, equities or corporate bonds do not meet all of the eligibility criteria of regulatory standards. These securities can be transformed to eligible collateral through repo or securities lending transactions.
In the same period, operational processes have improved across the board. In the decade before the financial crisis, more often than not, collateral management was back office activity which usually ran on spreadsheets. Exposures were frequently over collateralised to avoid daily movement of collateral between counterparties, particularly in the OTC markets. In the last decade, medium to large size firms have established robust technology and processes to manage end-to-end collateral flows. In addition, the industry has established best operational practices and benchmarks to enable standardisation and effective use of technology.
Can you discuss the evolving role of collateral diversification and its impact on the collateral management landscape?
Crowther: For years following the global financial crisis, central banks were accumulating various high-quality collateral as part of their quantitative easing policies. There was also an increased use of cash due to significantly lower interest rates. We also saw greater use of cash because of the much lower interest rates. As interest rates have increased and we have seen quantitative easing, the range of collateral available has increased and opportunity costs of different types have changed.
However, the primary driver of collateral diversification has come from the realisation that it is not just about the credit quality of issuers — it is about the market risk attached to different securities. The UK LDI crisis serves as a striking example of this shift, along with significant price fluctuations in various long-dated high quality government bonds.
Murphy: The combination of rising interest rates and new regulations have seen firms expand the types of collateral they pledge, requiring many to exchange non-cash collateral for the first time. For those with some prior experience in using these assets (for example where they have a sizeable repo or cleared book) the change has been simpler and has been more about increasing funding only. However, for others, the broadening of assets has required wider changes to systems; documentation and onboarding with triparty agents; connectivity to market infrastructure (SWIFT) etc. In turn, this diversification also increases the focus on collateral funding, leading firms to prioritise collateral optimisation as a way to minimise overall costs.
Edwards: Regulatory obligations have created a tight market for high-quality liquid assets (HQLA). Assets are considered HQLA if they are liquid and maintain their value in stress conditions. Another measure of liquidity is through the ease of sale or repo of the asset. Collateral diversification is key to mitigating market risk. Overexposure to a borrower, currency, sector, or asset class, creates concentration risk. Collateral’s ultimate goal is to protect the non-defaulting counterparty. In the event of counterparty default or market event, diversification helps to reduce liquidation costs for concentrated pools of collateral.
On the other hand, a less diversified pool may prove challenging to liquidate, or may need to be substantially discounted to liquidate. However, achieving diversity is not easy. It requires ongoing monitoring and review of collateral valuations, and making necessary adjustments to the pool. Operationally, the legal entity, physical locations of collateral and supporting market infrastructure are important elements in diversification considerations.
In addition, an important factor in driving changes in eligible collateral schedules (ECS) is the changing rates and profit margin environments. As lenders search for increased yield, their risk appetite has broadened during periods of low rates and stable markets, while the re-introduction of risk to the market over the past five years has led to a retrenchment of this approach as returns increased and risk aversion returned.
Engle: Collateral diversification plays a pivotal role in shaping the collateral management landscape, fostering resilience and enhancing market efficiency. As financial markets evolve, institutions seek to broaden their collateral horizons, tapping into new markets and asset classes to optimise their financing and derivatives activities. This shift towards diversification is exemplified by initiatives like J.P. Morgan Tri-party's expansion into new markets (eg Poland) and within existing markets (eg Japan, China Stock Connect, Korea, Taiwan), enabling clients to leverage a wider array of assets for collateral purposes.
By embracing diverse collateral options, institutions mitigate concentration risk, enhance liquidity, and unlock new opportunities for asset mobilisation. Furthermore, collateral diversification promotes market stability by reducing reliance on specific asset types or regions, therefore bolstering the overall resilience of the financial system. As the demand for collateral diversification continues to grow, collaboration between market participants and innovative solutions will further shape the collateral management landscape, ensuring its adaptability to evolving market dynamics.
Farhat: Traditionally, cash and government bonds are major forms of collateral. However, post-crisis regulations and challenging market dynamics increase collateral scarcity, liquidity pressure and concentration risk. To explore alternative, acceptable forms of collateral, optimise capital and liquidity, enhance returns and mitigate risk, firms tap more and more into a wider pool of collateral, including equities, corporate bonds or even alternative assets such as commodities, digital assets and structured products.
This brings several challenges to collateral management. First, managing a broad range of collateral requires robust processes to assess and represent asset eligibility in the collateral schedule, value collateral accurately and efficiently handle margin calls.
Second, it multiplies monitoring and optimisation of global collateral inventory complexity. Third, diversifying collateral holdings might also introduce more counterparty risk, which requires careful valuation and management. To cope with these challenges, the collateral management industry demands sophisticated systems capable of evaluating, monitoring and processing wide and evolving types of collateral in a centralised framework.
How do regulatory initiatives such as accelerated settlement and central clearing affect collateral management practices, and what measures are firms taking to enhance efficiency in compliance with these standards?
Edwards: The move to T+1 in the US and the upcoming changes to US Treasury clearing are continuing to drive the move towards automated, STP-based collateral and inventory management solutions. Our clients are well positioned to further develop their optimisation capabilities, as the use of intelligent solutions and frictionless environments such as State Street triparty enable the next level of alpha generation for their shareholders.
The disadvantage of this continued regulatory focus on transparency and risk reintermediation is that we will see costs increase for buy side firms in particular. The barriers to entry, along with the increase in liquidity buffer, and initial process friction, will not be appealing given the increased requirements placed on them in recent years, through requirements such as the UMR.
Farhat: Regulatory initiatives such as accelerated settlement and central clearing have profound effects on collateral management practices. A shortened settlement cycle requires firms to post collateral more quickly to fulfil transaction obligations. This places greater pressure to efficiently allocate and mobilise collateral in a timely manner. Mandates for the central clearing of derivatives, and soon, US Treasury and US Treasury repos, might increase margin requirements due to an increase in clearing activity and margin segregation requirements. It also shifts collateral management responsibilities toward managing relationships with CCPs and ensuring compliance with their margin requirements.
To optimise collateral allocation and ensure compliance, firms are centralising collateral management functions to achieve better control and visibility across business lines. This is facilitated by adopting a multi-function and multi-asset system that natively integrates collateral management functions with trading, risk management and settlement. Firms are also investing in advanced technology and automation, to streamline collateral operations from margin calculation and margin call management down to settlement and regulatory reporting.
Engle: Regulatory initiatives such as accelerated settlement and central clearing significantly impact collateral management practices, prompting firms to adopt measures aimed at enhancing efficiency and compliance with these standards. The transition from a T+2 to a T+1 settlement cycle in the US, effective 28 May 2024, necessitates swift adjustments to systems and processes to mitigate settlement risk and enhance capital efficiency. Firms face challenges in re-prioritising initiatives to align with the accelerated timeline, particularly in securities lending programmes where recall time frames must be condensed and processes realigned to prevent settlement fails.
Borrowers and lending agents are urged to adapt their procedures to ensure timely recalls and collateral returns. Triparty agents offer a streamlined and highly STP solution for managing non-cash collateral, minimising the operational hurdles associated with bilateral management. Additionally, central clearing mandates, especially for derivatives, compel firms to optimise collateral usage and explore end-to-end solutions. Buy side firms are increasingly outsourcing collateral processing to leverage expertise and reduce operational risk.
Collaborating with collateral managers facilitates holistic management, allowing firms to focus on strategic objectives while ensuring compliance with regulatory standards. These measures underscore the industry's commitment to adaptability and efficiency amid evolving regulatory landscapes.
Beatrix: Many regulations have direct or indirect effects on collateral. Reducing settlement cycles for example, implies reduced substitution cycles, in cases like the sale of a posted asset, which makes the recall a bigger challenge especially under a bilateral collateral setup. Together with the introduction of the Central Securities Depositories Regulation (CSDR) and settlement fail penalties, the impacts for firms can be substantial.
On another point, central clearing implies that cash is king for VM, which is a challenge for structurally cash-poor institutions like pension schemes hedging their liabilities with cleared swaps, and whose clearing exemption ended in June 2023. They have to maintain a structural cash ladder based on adverse market scenarios, while still achieving yield and remain as invested as possible.
The IM rules introduced completely new processes, with a significant adoption of triparty and the particular aspects of threshold monitoring, implying the need for the front office to monitor their trading levels with each counterparty carefully.
Crowther: One of the major side effects of central clearing has been to enforce a high degree of standardisation around both trading and collateral practices. Additionally, margin calls from the CCP must be promptly collateralised, regardless of whether participants agree or dispute the values reported by the CCPs. Both of these factors help to reduce friction and inefficiency in collateral management, even though some may miss the previous flexibility.
The transfer of collateral, as well as securities finance transactions, typically settle more quickly than transactions in the cash securities markets. However, the challenge arises when providers of collateral need securities back quickly, in order to settle any sales they make of those securities. This can lead to an increase in fails. While there are markets that settle on T+1, or have no tolerance for fails, these are not always the largest markets. If reduced settlement cycles cause more friction, larger markets will need to adapt and learn from them.
How does triparty collateral management support the transition to central clearing, and what role does it play in enhancing liquidity and efficiency in the collateral market?
Engle: J.P. Morgan Tri-party collateral management facilitates the transition to central clearing by offering the CCP Margin Exchange (CCPMx) solution, enhancing liquidity and operational efficiency for clearing members. By aligning with CCPs' preference for bilateral collateral delivery, CCPMx combines Tri-party's optimisation and eligibility engines with bilateral market movements. This approach simplifies collateral delivery and return processes, including intraday recalls, while optimising collateral selection and reducing operational burdens. J.P. Morgan Tri-party's role extends to managing collateral against margin obligations across multiple CCPs, streamlining connectivity and providing clients with a consolidated view of global collateral obligations across their securities financing and derivatives collateral activity. Through partnerships like with Baton Systems (Core Collateral), J.P. Morgan has connectivity to major CCPs globally, further enhancing liquidity and efficiency in the collateral market while simplifying collateral management for market participants.
Farhat: Triparty collateral management (TCM) bridges traditional bilateral collateral and central clearing. It facilitates collateral segregation and movement to and from the CCP. When a market participant pledges collateral directly with a third-party agent, this collateral is segregated from other assets and can then be used to fulfil margin requirements for centrally cleared transactions. TCM also reduces operational burden and simplifies compliance with CCP for clearing members by automating collateral operations, centralising record keeping, and standardising documentations and processes.
TCM plays a vital role in enhancing liquidity and efficiency in the collateral market. It enables efficient allocation and utilisation of collateral assets across multiple transactions and counterparties, ensuring that collateral is available when and where it is needed most. This improves overall liquidity in the market, mitigates counterparty risk and increases market resilience. TCM also contributes to a more efficient collateral landscape by accelerating collateral movements, reducing errors and minimising processing costs via automation and streamlining.
Edwards: As a triparty service provider, and through our Collateral+ solution, evolving market regulation offers us the chance to enable enhanced technology solutions to our clients with a view to gaining more returns from their inventory, reducing overall capital requirements and gaining access to a greater diversity of liquidity sources. Triparty can play a key role in this, supported by the continuing development of the interoperability approach, by reducing physical settlement requirements and enabling ‘round the clock’ collateral mobility.
As our clients step up to driving value creation throughout the end-to-end trade cycle, State Street Triparty has a key role to play in both the traditional and digital landscape.
What role does technology, particularly AI and blockchain, play in innovating collateral management processes, and how can firms ensure successful integration and adoption of such technologies?
Crowther: Collateral still exists in silos and there are still the associated costs and frictions of managing collateral on a global basis. Broadridge has used DLT to help make it easier to mobilise collateral and is developing AI solutions that help deal with the frictions that occur in the post-trade processes.
Successful adoption and integration of technologies, such as artificial intelligence and blockchain, ultimately depend on being laser focused on the problem that needs to be Solved, as well as picking the right tool for the job. This is the approach Broadridge has taken, and it has helped to get our new products into production at multiple clients.
Murphy: The collateral management process has historically been resource-intensive, demanding significant time and financial investment for daily operations. Consequently, it stands to benefit greatly from technological advancements that can streamline processes, reduce costs, mitigate risks, and minimise manual intervention. Recent advancements in technology, particularly in margin call messaging and reconciliation, have centred around the adoption of standardised industry platforms, enhancing connectivity for all market participants.
To ensure widespread adoption, future innovations — including the adoption of AI and blockchain — should follow a similar approach. They should aim to minimise barriers to adoption, offer cost-effective solutions, and deliver clear and demonstrable benefits. Given the bilateral nature of collateral management, improvements must cater to firms of all sizes, not just the largest players, ensuring accessibility and usability across the industry.
Farhat: Technology, including AI and blockchain, is transforming collateral management by offering greater efficiency, cost reduction and risk mitigations. AI has the potential to automate decision making processes, such as collateral optimisation and risk management, and perform predictive analysis on future collateral requirements. Blockchain can enhance efficiency by improving transparency and traceability of collateral records, reducing intermediaries, and increasing liquidity and accessibility of collateral assets.
To ensure successful integration and adoption of such technologies, firms must invest in robust, scalable and modern infrastructure and technology platforms. These investments lay a solid foundation — they enable centralisation, automation and digitalisation, and allow firms to adapt swiftly to new technological advancements. Collaboration with technology vendors and industry partners is also crucial to facilitate the integration of technology innovations.
Engle: Technology, particularly AI and blockchain, is revolutionising collateral management processes by enabling optimisation, cost reduction, and asset mobilisation. AI aids in optimising collateral on a broader scale, while blockchain technology facilitates the tokenisation of assets, unlocking their value and streamlining their mobilisation. For instance, J.P. Morgan's Tokenized Collateral Network (TCN) leverages blockchain to enable near-instantaneous settlement of collateral transactions, enhancing liquidity and efficiency.
Tokenisation enables the release of ‘trapped’ assets and adds utility to — and removes mobility friction from — highly liquid assets. For example, BlackRock and Barclays used TCN to deliver money market fund (MMF) collateral for an OTC derivatives trade. This solution transformed the usage of an asset class that was nearly impossible to mobilise as collateral to a near-instantaneous transfer of MMFs at the time of the margin call.
Successful integration and adoption of these technologies require firms to prioritise interoperability, ensuring seamless connectivity with existing systems and platforms. Moreover, firms should invest in robust cybersecurity measures to safeguard sensitive data and build trust in these innovative solutions. Collaborating with industry partners and regulatory bodies can also facilitate standardisation and promote widespread adoption, driving further innovation in collateral management practices. By embracing cutting edge technologies and fostering collaboration, firms can navigate the evolving landscape of collateral management with agility and efficiency.
Edwards: The technology evolution is not slowing down, and all financial services firms are technology firms in one shape or form. The adoption of AI and distributed ledger technologies (DLT) is taking place in differing ways. While some firms have been looking at revolutionary approaches, at State Street, we see the best results coming through market alignment via evolutionary methods. The use case for DLTs to enhance collateral mobility and globalisation of domestic asset liquidity is clear. Combining this with our triparty platforms brings the next level of inventory efficiency for our clients.
While the initial process developments for AI are to enable greater responsiveness and effectiveness in resolution of the remaining manual processes in the collateral chain, such as enhanced dispute management and client reporting. An innovation mindset is key for us at State Street, as we help our clients to adapt to a landscape where the pace of change continues to accelerate.
How are firms addressing recent liquidity stresses in the market, and what innovative solutions are being offered to provide clients with greater flexibility in managing liquidity needs?
Edwards: Market stress events throughout 2020, 2021 and 2022, have caused market participants to think more carefully about their liquidity needs and associated management. Historically, many buy side market participants have fulfilled their collateral obligations by sourcing inventory against exposures on a like-for-like basis across accounts within the same legal entity, or by running cumbersome internal processes to aggregate inventory into one account to cover all exposures under that legal entity.
Increasingly, market participants are turning to robust optimisation engines to allow them to specify algorithmic rules for sourcing inventory across their account range into centralised collateral inventory accounts or long boxes. The inventory in these long boxes is then used to facilitate settlement against counterparty exposures according to client configured rules. Clients are able to configure the allocation of inventory from their accounts to the long boxes and from the long boxes to counterparties as best suits the needs of their trading relationships.
Settlement of inventory between client custody accounts, long boxes and counterparties, is automated by the optimisation engine to improve process efficiency. These solutions enable market participants to deploy inventory from multiple sources in the most optimal manner possible across their trading agreements, and allows them to improve the efficiency of their portfolios, reduce liquidity risk, and help facilitate the deployment of more inventory towards higher value activities.
Beatrix: The implied cost of collateral in derivatives pricing means that cash remains somehow king on the OTC market. In fact, there is no other option on centrally-cleared OTCs, while the latest ISDA surveys show that cash remains favoured on non-cleared OTCs — despite a slight decrease in the use of cash versus securities compared with two years ago.
Repo facilities can be an option to ease the sourcing of cash for cash-poor players, as these offer an option to source cash at a cost possibly cheaper than the funding cost implied in the derivatives price assuming securities collateral.
Besides, there have been moves recently to facilitate the eligibility of tokenised assets as collateral, such as the Tokenized Collateral Model Provisions in the ISDA Credit Support Annex (CSA), or the Luxembourg Blockchain III Law. However, the gains observed on tokenisation so far at proof-of-concept level are still limited, especially with regards to the collateral traps they could create versus the rest of the market (assuming adoption remains limited and DLT networks are not interoperable).
Blais: In times of collateral stress, one can look at utilising non-traditional pools of liquidity, such as assets traditionally held and kept in local markets, as a start.
Indeed, as some markets require segregated account structure, beneficial ownership records come with other local requirements that usually make it too difficult to use these assets as collateral in triparty. By exploring the ability to leverage domestic pools of collateral in segregated or emerging markets, firms can find alternative ways to bring additional supply into their global collateral inventory.
Another way to minimise the impact of liquidity stress is to ensure that collateral is mobilised with a near 100 per cent efficiency rate. To do so, either via triparty modules, or through their own models, trading firms should test collateral allocation and eligibility prior to moving inventory, and even before committing to trades. This allows front office collateral managers to anticipate funding needs, avoid collateral shortfalls when possible, and reduce operational costs by guaranteeing eligibility prior to committing collateral pools.
Engle: J.P. Morgan Tri-party has been working with clients on various innovative solutions that support greater flexibility in managing liquidity needs. One approach involves mobilising assets that are traditionally hard to finance or post as collateral. J.P. Morgan has been collaborating with triparty clients to support structured financing and unlock the value of assets like restricted shares, loans, and MMFs for financing activity. By leveraging J.P. Morgan Tri-party’s capabilities to un-trap and optimise assets, firms can realise the value of these assets to support overall market liquidity, and generate incremental returns while managing collateral to meet capital and other binding constraints.
J.P. Morgan Tri-party also continues to invest in enhanced inventory management capabilities including reuse, multisource longbox, triparty interoperability and collateral transport. Reuse, multisource longbox and triparty interoperability (J.P. Morgan Tri-party and Euroclear) enable clients to seamlessly move assets across global entities, counterparties and triparty agents (ie J.P. Morgan Tri-party and Euroclear) without the limitations of settlement friction or market cut-off times. Collateral Transport orchestrates asset mobilisation across custody, lending and triparty through the J.P. Morgan Agency Securities Finance platform, enabling assets to be transported swiftly between custodians and triparty agents for lending and fulfilling margin obligations.
By leveraging these innovative solutions, firms can adapt to changing market conditions and better meet their clients' liquidity needs with increased flexibility and efficiency.
Farhat: Firms are managing recent liquidity stresses through a multifaceted approach, which includes:
Diversification of payoffs and strategies. Financial institutions seek balance sheet optimisation by reducing capital charges or lowering funding costs. This can be achieved through new payoffs like evergreen and triparty trades, as well as alternative cash exchange strategies, such as synthetic repo, fully funded swaps, synthetic margin lending and margin loans.
Emergence of central funding units. Fixed income and equity desks are collaborating to optimise the firm-wide securities inventory, empowering traders to make informed decisions on cash and collateral allocation promptly.
Growth of agency lending and prime finance business. These activities enable banks to earn income on capital and generate returns on idle securities holdings, thereby strengthening their balance sheet and mitigating various risks.
To leverage these strategies, firms need advanced technology that offers a rich and evolving library of payoffs across assets, centralise inventory and liquidity management across the organisation, and streamline operations front-to-back-to-risk.
Crowther: For the last few years, there has been a trend towards converging operational cash management and liquidity management, typically performed by a trading desk or treasury. Market movements over the last year have accelerated this.
Periods of extreme market volatility drive more intraday margin calls by CCPs. That means greater need for intraday liquidity. Part of the solution provided by systems is the ability to have a more real-time view on liquidity. Another aspect is the creation of tools that support intraday funding. Broadridge, for example, has introduced tools that support intraday repo transactions.
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