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Analysis

Prepare for the coming collateral crunch

by Hani Kablawi

Prepare for the coming collateral crunch

New regulations, heightened risk sensitivity and rapidly evolving market dynamics are all making collateral management more critical than ever, as buy-side and sell-side firms alike find themselves confronted with new challenges and new complexities.

Collateral has always been integral to the extension of credit, but it is fast becoming the sole determinant of institutions’ ability to engage in financial transactions in the cash or derivative markets.

As our clients’ business models continue to evolve, they are increasingly looking for unified capabilities across collateral management and segregation in order to more effectively address regulatory changes, manage risks and improve performance.

In particular, those regulatory changes – Liquidity Coverage Ratio-friendly deposits, Money Market Reform, Dodd-Frank, European Market Infrastructure Regulation and Basel III, among others – require an extension of optimisation capabilities to the buy-side, along with the delivery of enhanced operational efficiencies.

The ability to identify, mobilise and – if necessary – transform idle assets to be used actively as part of an overall investment strategy remains key. How quickly can you access your collateral? How liquid is it? Do you have the right type of collateral and, if not, are you able to transform the securities you currently hold into acceptable collateral?

The impact of many of the new regulations – Solvency II, Basel III, Emir, central clearing – is just beginning to be felt in the market, but what is clear is that balance sheet management, liquidity and more effective financing are key challenges for an increasingly broad range of participants who must balance these drivers with a range of other priorities, such as risk mitigation, cost and operational efficiencies.

Future financial institutions and intermediaries will need to find new and efficient ways to collateralise and fund liquidity, and identify partners who can help them repurpose common platforms that will allow them to address future collateral eligibility needs.

With collateral segregation and optimisation still key areas of focus, the future of collateral management is also about efficiency, with clients increasingly seeking out the most direct and effective approach to collateralising their assets.

While the predicted ‘crunch’ in respect of the volume of assets to be collateralised did not materialise, a crunch is still coming in terms of the number of collateral accounts that need to be opened. The operational resources required for processing – including account set-ups, reconciliations and legal agreements – will become a more pressing priority for clients.

Despite legislative exemptions from many of the regulatory reforms that have transformed the derivatives market, sovereign investors are feeling the indirect effects of the impact of these reforms on their counterparties.

Recognising and responding appropriately to that impact will deliver cost and risk benefits over the second half of this decade. 

■ Hani Kablawi is executive vice-president and chief executive of EMEA Asset Servicing, and co-chair of MEA, BNY Mellon.

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