Margining & Collateral: The New Operating Model

This is the second white paper in our series addressing the margining and collateral challenges facing the banking industry. The first paper examined the regulatory timelines and emerging vendor utility
December 8, 2016 - Editor

This is the second white paper in our series addressing the margining and collateral challenges facing the banking industry. The first paper examined the regulatory timelines and emerging vendor utility ecosystem. In this paper we look at potential disruption to the business operating model facing sell-side and buy-side firms caused by BCBS/IOSCO regulations relating to the margining of non-cleared OTC derivatives. We provide a framework for understanding which areas will be impacted and suggest an approach for planning your response.

This is the second white paper in our series addressing the margining and collateral challenges facing the banking industry. The first paper examined the regulatory timelines and emerging vendor utility ecosystem. In this paper we look at potential disruption to the business operating model facing sell-side and buy-side firms caused by BCBS/IOSCO regulations relating to the margining of non-cleared OTC derivatives. We provide a framework for understanding which areas will be impacted and suggest an approach for planning your response.

In summary, sell-side and buy-side firms must be ready to exchange variation margin (VM) by March 2017, and initial margin (IM) at some point from September 2016 onwards depending on the scale of notional OTC outstanding. The penalties for margin disputes are potentially severe, but capabilities for IM/VM calculation and dispute management may be inadequate or even non-existent in some firms. Third party vendor and utility solutions are rapidly emerging, but it is by no means clear how these might fit together to form an effective solution.

We believe each firm must rapidly understand the impacts of these changes on their business operating models, addressing key dimensions such as business process and work flow, functional requirements, controls and technology. In this paper we set out some of the key process changes impacting pre-trade processing, margin calculation, dispute resolution and collateral operations.

Whilst some firms may not be impacted by the IM margining regulations for a while yet, we suggest that firms should design a strategic target state that addresses IM as well as VM. This is likely to guide the firm towards the most efficient and lowest cost target state in the long-run.

If the target state is not yet well defined firms should start work immediately on their target operating model, engage with the emerging utility / vendor solutions, and should set out a clear roadmap and business case to define and justify the journey. If you haven’t started already, the time is now.

Operating model framework

The starting point is to understand what impact these changes will have on your business operating model. Operating models are complex, multi-dimensional representations of how the business works for which there is no industry standard definition. But over many years of real-world banking projects The Field Effect has developed a powerful framework which helps accelerate solution design. We use this framework to understand the impacts of impending change initiatives such as margining non-cleared OTC derivatives.

Our model spans six critical dimensions:

  • Processandcontrols Collateral
  • Functionality and technology
  • Data and information
  • People and actors
  • Products and services
  • Geography

The power of this framework is its ability to capture and link detail at the lowest level, whilst being able to visualise the model at high level on a single page. Figure 1 illustrates simply how the TFE framework links business processes to actors that carry them out, and technology services required to support them, thereby aligning people, process and technology. Many other cross-linkages are possible in the model but for brevity we will not cover them here.

To accelerate operating model design projects the framework is supported by a knowledge library of pre-codified processes and functions covering the end-to-end margining processes for buy-side and sell-side firms, CCPs and custodians. It’s invariably faster to design the target state if there is a “strawman” starting point to critique instead of a blank sheet.

Non-Cleared margining process flow

Using this framework we can identify seven key activities within the non-cleared margining process, shown at the highest level in figure 2. Invariably the “devil is in the detail” – these seven Activities can be disaggregated to around 30 Tasks, each comprising 5-15 low level Steps. Typically, we find organisations share a common Process / Activity / Task model – the differences emerge primarily at “Step” level where organisation-specific work flow is defined. Again brevity prevents us drilling down into detail in this paper, but it is at the lowest level the operating model impacts must be identified.

This provides a high level framework for identifying the main operating model impacts at each Activity within the Process.

Operating model impacts

Taking each Process/Activity in turn we have set out some of the key business impacts.


With the rising cost of margining non-cleared OTC derivatives, a pre-trade question arises for buy-side firms about whether to hedge exposure with an OTC or whether to imperfectly hedge with (say) futures at lower cost. Even if OTC is the better route, a pre-trade question arises about whether to clear (if that is an option) or not. These pre-trade decisions must be supported by margin simulation and likely cost data, and the locus for these decisions rightly belongs in the front office. This requires new functionality, new data, a new process with new controls and decision capture, supported by new technology.


Impending MiFID II regulations require firms to take “all sufficient steps” to achieve and evidence best execution. The cost of financing the margin obligations of an OTC derivative may need to play a part in the choice of execution counterpart, taking into account any collateral off-setting effects. Balance sheet utilisation and capital costs must also be taken into account when choosing execution venue. New cloud-based software platforms are emerging that capture execution choices and preserve price and cost information to support post-execution audit – for some firms these will provide a better solution than Excel. Trades will also need to be reported to a Trade Repository, along with collateral values.

IM/VM Calc & Lifecycle events

One of the biggest operating model impacts on all firms is the need to issue daily variation margin calls. Many buy-side firms are subject to periodic Independent Amount (IA) margin calls. In the new world, not only will they need to process daily incoming VM calls but they will need to calculate and issue VM calls to their counterparts, with extra complexity if calls are not in the underlying currency of the swap. Over time all counterparts will also need to be able to calculate and issue IM calls to their counterparts and to validate and process non-nettable incoming IM calls. Starting with the largest firms (€3tn + notional) in 2016 the threshold will be lowered annually until all but the smallest firms are caught. The complexity is not the calculation per se, but the need for historical and stress data to support the calculations. Numerous third party calc vendors and utilities are emerging that offer partial solutions – the question is how will these fit into an overall solution, what controls are needed to ensure the solution is operationally robust, and what technology is needed to avoid costs rising out of control to support new processing volumes.

Margin call agreements

Another major operating model change relates to agreeing margin calls. Historically buy-side rms may not have been well equipped to challenge broker calls and even sell-side firms may have relied on “splitting the difference” between bilateral calculations rather than investigating underlying discrepancies. TriOptima’s triResolve and AcadiaSoft’s MarginSphere have provided portfolio reconciliation and margin / collateral matching services but with limited buy-side take-up. The new regulations impose onerous collateral costs through doubling the Margin Period Of Risk (MPOR) for unresolved disputes, so firms must design effective processes for investigating margin disputes through portfolio and risk sensitivity reconciliation, and through understanding differences in market data and margin models.

Collateral Processing

Another area of significant operating model impact is the selection of collateral to meet margin calls. Funds may choose to reduce holdings to raise cash for margin calls – but at what cost in terms of performance drag? Alternatively, they may seek to post securities if the fund’s assets meet the counterpart’s eligibility requirements, or they may repo securities / lend stock to raise cash. Firms will need to establish processes and controls for accepting cash and non-cash collateral, incorporating controls for eligibility, concentration and wrong-way risk.


Finally, settlement processing will also be impacted. Firms will need to establish custody facilities with legally robust margin segregation supported by new agreement documentation to ensure safe recovery of assets in the event of default. This is likely to require connectivity to market infrastructure such as iCSDs and triparty agents who have developed settlement infrastructure to automate book transfer of assets via RFQ (Request For Value) messaging, enabling outsourcing of processes such as eligibility checks and settlement reporting. New utilities such as the DTCC/Euroclear Margin Transit Utility (MTU) offer settlement message enrichment and connectivity across multiple triparty agents. Firms who outsource operations to third party Fund Administrators will need to work out precisely which party is responsible for what parts of the process, ensuring adequate controls and reporting are in place to evidence accountability.

Design your own solution

Once the firm has understood the extent of the impact on its business, the next step is to agree the vision and target operating model, evaluate solutions, set out the roadmap and secure funding.

Vision & objectives

In our experience is it critical to agree the vision and objectives of the organisation. This does not need to take long, but any change initiative needs a clear executive steer on “what good looks like”.

Target operating model

Next comes the target process model: identify each of the impacted business processes and map end-to-end the embedded Activities, Tasks and Steps. Identify preventive and detective controls at the Step level, mapping the data, technical services and actors involved at each point. This provides the detail to aggregate technical services into a target Functional Model to drive business requirements documents and any vendor / third party RFPs. Aggregation of Actor roles in non-automated Steps helps define any organisation change in roles and responsibilities. This requires both subject matter experts in the current business, but also enough “change agent” facilitation to design a target state that meets the organisation’s vision and objectives.

Solution design

In parallel it is vital to understand existing and rapidly emerging solutions, to assess what might be outsourced to whom, and how 3rd party infrastructure components and services can be pieced together jigsaw-like to form the right solution for your firm. The iCSDs, custodians and service providers have launched a variety of more-or-less integrated services in this space, and independent software vendors have developed on-premise and cloud-based solutions at much typically lower cost than in-house build. Our first white paper describes the vendor / utility landscape for margining non-cleared OTC derivatives – worth a read if you haven’t seen it.


Once the right solution for your firm is clear the next step is to identify the major units of change – the programme building blocks – needed to get you to the target state from where you are today. We find it useful to identify the resources, skills, costs and duration of each building block, to allow rapid assessment of what needs to be done by when, and how “do-able” the change programme is.

Business case

Generating a financial business case can be semi-automatic if costs and bene ts have been attached to those building blocks, and even for regulatory initiatives a business case is often necessary to submit to secure multi-year budgetary funding.

Key questions

Deciding how to build your margining picture is not a “one size ts all” exercise. You need to analyse the impacts on your current model and ask yourself a number of questions: should you have a centralised collateral management function working across business unit silos to optimise use of the firm’s inventory and minimise the cost of margining? What are your operational capabilities around margining but also surrounding the introduction of non-cash collateral, triparty agents, multiple prime brokerage & custodian relationships? How many of these relationships do you want? What are the cost implications? How much automation do you require? How scalable do you need your solution to be? What opportunities can you spot? How ready is your firm for change? How much can you really outsource?

If the target operating model is the ‘what’, your solution options are the ‘how’. Whilst your target operating model will define your optimal state, you will almost certainly need to phase the delivery programme. There are a variety of different industry actors providing a range of infrastructure services supporting you at various points during the process. We have identified 18 different solution providers who can help. How exactly these actors fit into your solution (if at all) is a firm-specific decision that depends upon a variety of factors and policies:

  • Strategy
  • Budget
  • Requirements
  • Timeframes
  • Outsource vs in-house
  • Vendor vs utility; build vs buy

Whilst the target state operating model will include all of the activities and tasks mentioned above, the decision as to how you actually implement the model still remains. Understanding the different solution types will help you to piece together the right solution for your firm.

This article was first published in a special edition of Rocket, our magazine, which was available to attendees at The OTC Space and The Field Effect breakfast briefing, held on the 7th of April 2016. This special edition is now only available as a PDF, which can be purchased through The OTC Space Shop. The live event is also available to watch via The OTC Space YouTube channel

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