Change is the only constant in life – Heraclitus
Sometimes it is subtle, like the gradual shortening of daylight from summer to autumn. Once in a lifetime (hopefully), it is driven by a global pandemic that affects the entire population, presenting unforeseen social, economic and operational challenges to both work and personal lives. Likewise in the collateral world, amidst the steady journey of complying with regulatory reform (Basel III, Mifid, UMR), many firms suddenly faced unprecedented challenges driven by market turmoil, volume spike, increased margin calls, shrinking liquidity, all while swiftly implementing all-remote operational processes that even the most extreme business-continuity plan could not have foreseen.
The year 2020 has proved that change is not only constant, but unpredictable. The ability to utilize change as a catalyst for transformation will be the difference between success and failure for many firms.
At the height of market volatility in March, spikes in volume with plummeting asset valuations led to missed margin calls, settlement fails, communication breakdown and reporting delays. In the following months, institutions across buy-side and sell-side identified gaps and vulnerabilities in their collateral management operations that are in dire need of transformation. The crisis has highlighted the importance of establishing and maintaining an advanced and agile infrastructure that effectively mobilizes data on a real-time basis to provide immediate views of credit exposure, counterparty risk and asset inventory, thus enabling optimal allocation of collateral throughout various stress scenarios.
Regulators acted swiftly in April to propose a one-year extension for phase 5 & 6 of UMR compliance, providing many financial institutions the relief needed to focus on mitigating risk and ensuring business continuity. This delay also presents an opportunity for firms to review their collateral management capabilities and consider an approach to UMR compliance that is strategic rather than tactical.
Taking such an approach cannot come at the cost of BAU efficiency. When assessing the opportunity to partner, firms should look for a vendor that can quickly onboard customers to their solution. It should be a comprehensive and modular solution, benefitting from continual investment to ensure current and future needs are met. This will promote the strategic evolution of collateral management operations from both an infrastructure and regulatory compliance perspective
Systems Integration & Automation
In a world of electronic trading, nanosecond executions, artificial intelligence and digitalization, many firms are still struggling with fragmented collateral management operations that rely heavily on a patchwork of batch-driven software and manual workarounds. While a drastic infrastructure change may be needed to address the operational vulnerabilities that were exposed earlier this year, a sudden “rip and replace” overhaul of incumbent systems may not be feasible.
With the looming threat of a second COVID-19 wave and uncertainty over the future of the global economy, firms should consider the implementation of an integration platform that seamlessly connects to all existing systems, standardizing data across business verticals while providing flexibility and scalability to automate processes to better handle any potential volume spikes or data complexity. Designed for modern workloads, the integration platform should provide digital and technological components for users to engineer intelligent and innovative solutions quickly, thus allowing business transformation to proceed at the pace that is unique and relevant to each institution.
Quality Data and Industry Connectivity
The quality and timeliness of financial data is crucial to operational resiliency, as it provides firms with the information required to quickly react to threats and opportunities. As the market turbulence in March triggered massive swings in margins and asset pricing, the need for a real-time holistic view data of cross-product margin obligations, asset inventory and collateral settlement status became starkly apparent. However, this proved to be a barrier for many firms as the lack of data transparency resulted in missed margin calls, settlement fails and suboptimal collateral allocations.
Data should be the solution, not the problem. Achieving data fluidity depends on both the interoperability of systems within a firm’s infrastructure, and connectivity to the external network of industry utilities. A collateral management solution should be fully integrated with established solutions that can systematically manage trade data, margin, messaging and collateral data from counterparties, custodians, triparty agents, CCPs, etc. By centralizing the data flow in enabling real-time views of counterparty risk, margin obligations, asset availability and collateral eligibility, firms can drive operational efficiency and enable optimal use of capital.
Asset Inventory & Optimization
Over the last few years, the topic of asset optimization has been brought to the forefront as regulations (i.e. Dodd-Frank, EMIR, UMR, Basel III, etc.) increased the demand for HQLA held as collateral, resulting in liquidity strain across all financial institutions. This effect was compounded in March as market volatility drove up margin demands across the cleared and uncleared derivatives space, highlighting the need for firms to establish a centralized view of inventory, robust collateral analytics and automated optimization capabilities.
Implementing a sophisticated asset optimization solution that utilizes real-time inventory, obligation and market data can alleviate the operational burden of manual allocation while identifying cost-savings and revenue opportunities. All allocation methodologies should consider a number of baseline factors, such as agreement terms, margin requirements, regulatory constraints, eligibility rules, etc. An advanced optimization platform provides the ability to fine-tune parameters to create customized optimization strategies based on a number of other variables including fund composition, investment strategy, risk tolerance, obligation type, delivery priority, business line and cost to deliver.
In looking to the future and bracing for more uncertainty, firms should establish optimization processes that can be automated to provide stability (asset allocation will continue to occur based on pre-defined algorithmic strategies) and agility to allow for a rapid shift in strategies in response to market stress and opportunities.
The world is at a tipping point as some areas reopen with the easing of COVID-19 restrictions. Are we prepared for a new normal? What is the new normal? Will there be a second/third wave? If we have learned anything from 2020, it is to expect the unexpected, that change will happen (however gradual or sudden), and the ability to be agile coupled with the readiness to transform will be the key to success for all organizations.
At VERMEG, we specialize in partnering with our clients as they navigate through the challenges of business and digital transformation. Our modular solutions allow our clients to define goals and target operating models that leverage enhanced technology that best fit their evolving business strategy.