Capco highlights why collateral management is central to regulatory change and the Business opportunities it creates if you get it right.
Capco, the global business and technology consultancy dedicated solely to the financial services industry, has observed a seismic shift in how Collateral Management is viewed in many financial organisations since 2008. With the credit crisis driving continued regulatory change, Collateral Management is changing from a reactive, largely administrative function in the back office to being integrated with Trading (Collateral Brokering and Securities Finance), Liquidity Management, Credit Risk, Market Risk and Finance (Capital Adequacy).
Financial institutions continue to face major challenges with regard to the scale of reform required, but the prize for those organisations that respond effectively will include additional client and revenue flows, as well as proactive Risk and Liquidity Management that improve business performance.
Stephen Vinnicombe, a Capco Partner, comments: "While investment costs associated with 'revolutionising' the way Collateral Management is viewed will be high, the benefits of doing so are wide-reaching. Capital Adequacy (banks are 30-40% inefficient on RWA valuations), Liquidity (single counterparty and issuer views to enable proactive management) and New Business opportunities (increased Collateral Trading and Tri Party activity) all stand to improve measurably and significantly, making the costs and consequences associated with doing nothing even greater.
"Financial institutions need to consider the following seven points if they are to successfully integrate Collateral Managementacross their organisation:
1. Risk management
The ability to re-assess counterparty risk on a near real-time basis and make appropriate credit valuation adjustments (CVA) across client and counterparty portfolios will be essential to improving margin and threshold management, handling of concentration risks and identify trading opportunities.
2. Integration across product types
Many banks still have a silo-based Collateral Management environment between products with individual margin calls. Exposure and Collateral Management should be amalgamated across product lines to achieve efficient cross product netting and consistent pricing.
3. Integration between business functions
The criticality of Collateral Management to business performance demands a move from reactive focus to a pro-active intra-day approach across Front Office, Finance, Operations, Credit and Market Risk. .
4. Introduction of CCPs
Separation of wholesale (CCP) and client collateral flows (bilateral) is required which could increase overall exposure. The industry is considering netting across CCPs e.g. ICE Trust and CME (credit derivatives and commodities) and LCH Clearnet (interest rate derivatives), using agreed risk arrays across open trades, and also including exchange traded activity. The intraday margining of the CCPs will increase focus on the STP capability of all firms.
5. Client servicing
There are a range of requirements clients are looking to their Collateral Managers for:
- Consolidated margin calls
- Intraday facilities
- Trading and substitution opportunities
- Straight through processing (STP)
6. Efficiency, STP and operational risk
There will be a rapid increase in the frequency of collateral management activity with the standard shifting from batch to real time and the volume of activity will test whether firms have got the right levels of STP and control in place to manage efficiently.
7. Business model
There is a broader business model question to answer as to the relative roles of the traditional Investment Bank, Prime Broker and Custodian in the provision of the next generation of Collateral Management services. The banks that emerge from this era of change the strongest will be those that have harnessed the "Back Office" strengths of custodians and their huge balance sheets with the "Front Office" CVA, Pricing, Capital Adequacy and trading opportunities.
