Variation margin (VM) requirements came into force for tier-two and tier-three firms in March 2017. In a recent DerivSource webinar, Farid Rahba, head of product management for collateral management at Murex discussed collateral usage challenges firms face as they prepare for the next wave of deadlines and the strategic advantages of moving to a new operating model and revamping data management.
Regional banks and buy-side firms can learn a lot from the chaotic rollout of BCBS/IOSCO variation margin (VM) and initial margin (IM) requirements for tier one banks last September and earlier this year, when many of those institutions that were late with their preparations adopted the requirements. While the March deadlines have now passed, there is still a lot to prepare around documentation, and getting ready early and addressing challenges, could help tier-two and three firms avoid falling into the same trap.
Buy-side institutions face challenges over collateral usage
While the market has been moving towards simplification – VM settled in cash and IM managed at tri-party agents - some types of firms face specific challenges, pension funds for example. Clearing exemptions will come into force in Europe in 2018, also requiring pension funds to use cash as collateral for VM. Many of these institutions are securities rich, and would prefer to post securities as collateral rather than cash, which they will have to secure via the repo market, for example. In parallel, using securities as collateral has become difficult considering T+1 settlement requirements. Pension funds need to start thinking about their collateral usage now, reinforcing the need for a robust framework for collateral mobilization and transformation.
Firms adjust operating models, data strategies
Many firms have had no choice but to adopt a reaction-based approach in order to be compliant and to ensure continuity in their trading relationships. However, it would be preferable for firms to think long-term—strategically rather than tactically.
The buzzwords in the industry—breaking silos, margining across business lines, optimisation—point to the fact that collateral is much more than an operational function. In many cases, these are the same strategic challenges people have been talking about for the last four years – since the Basel Committee released the final framework for non-centrally cleared derivatives. This says a lot about how complex this endeavor is!
Many of our clients are changing their operating models, breaking down silos, and sharing assets and business processes across cleared and non-cleared margining, repo and securities lending. It is a long journey and there is still much more work to do. These operating model changes have begun to have a real impact on firms, as well as on our relationship with our clients.
Another major aspect of taking a more strategic approach involves investing in technology and data management. Many firms are increasingly moving towards having a single source of the truth or data—for legal information for example—to aid the margining process, perform credit valuation adjustment (CVA) calculations, as well as OIS discounting according to CSA terms.
Technology investment is also key as it can be a strategic enabler to the necessary operating model changes. Having a single source of the truth makes collateral management more efficient as collateral touches many different parts of an institution. Firms need to think long term as they look towards the next set of deadlines and build their strategy for how to meet these operational challenges.
To view the webinar recording on non-cleared margin requirements, please click here.