A great deal of change is coming to the collateral management world over the next few years. With mandatory clearing and non cleared margining already well on their way to implementation, a good deal of firms whose relationship with collateral management may well be tangential will need to start thinking about it. Specifically Tier 2 banks, corporates, pension funds and buy-side firms will either need to expand or create their collateral management capability in order to satisfy regulation. Implementation of regulation is on a sliding scale all the way to 2020, so understanding when your operations will be hit is key.

A great deal of change is coming to the collateral management world over the next few years. With mandatory clearing and non cleared margining already well on their way to implementation, a good deal of firms whose relationship with collateral management may well be tangential will need to start thinking about it. Specifically Tier 2 banks, corporates, pension funds and buy-side firms will either need to expand or create their collateral management capability in order to satisfy regulation. Implementation of regulation is on a sliding scale all the way to 2020, so understanding when your operations will be hit is key.

Note: This article was written for our Margin Breakfast in April 2016. Since then NetOTC has closed down, but remains below for reference.

We have put together two papers, the first explaining the regulation and current state actors in collateral management, as well as emerging vendor solutions. Secondly we have put together a readiness guide for smaller sell-side and most buy-side firms to help you understand how to prepare for impending shifts. This paper will outline the regulation, timelines, current collateral management actors & emerging platforms.

• New platforms have arrived which offer some or all of the collateral work flow process
• The approaches provide a centralised approach to the process to which a user will need to integrate both technically and operationally
• The need to calculate Initial Margin using a model approved by regulators is supported by the new platforms, which all providers will need to address
• By March 2017, all firms must exchange Variation Margin on their new trade portfolio, meaning considerable upheaval to process the “new” and “old” portfolios in parallel
• As Baden Powell once said “A Scout is never taken by surprise; he knows exactly what to do when anything unexpected happens.”
• The second paper explains an approach to preparing for these changes

Regulatory requirements

To see Figure 1 is to understand the seismic shifts that will impact the industry over the next few years. Whilst you may be hit by a number of these regulations we are going to focus on the collateral management space. Mandatory clearing (EMIR) and non cleared margining (BCBS 239) are both scheduled to bite the industry incrementally from 2016. When you couple cleared and non cleared together the sheer volumes of margin which will now need to be calculated & exchanged will be astronomical. Whilst it is without doubt that mandatory clearing will be having an effect on the internal operating models of rms, we see the biggest impact on Tier 2s, Buy-side and Pension funds being non-cleared margining. The BCBS requirement is to exchange Variation Margin (VM) on new contracts (with a minimum threshold of €500k) from September 2016. This requirement only applies if the month end average notational amount of non-cleared derivatives at the institution in March, April & May 2016 exceeds €3trillion. Most, if not all, firms hit by these initial requirements will already have significant margining capability and, whilst we don’t seek to minimise the impact on their operating models, implementation programmes should be well under way.

From March 2017 all covered entities will be expected to exchange VM and will be subject to the phasing in of Initial Margin on a sliding scale reaching, at its lowest point, €8bn notional in 2020. All covered entities need to build a Variation Margin capability by March 2017 and seriously consider when the work needed to build an IM capability should be completed.

Mandatory clearing is being rolled out with firms allocated to Categories, according to the average notional size of their OTC portfolio. The diagram shows the timing of each category starting this year for Category 1 and 2 firms. Category 2 firms will need to meet the clearing regulations in 2016 and the un-cleared margin regulations in 2017, meaning the need to master the calculation and management of Initial Margin isn’t far away. We would argue that the Target Operating Model for margined business needs designing once only, and should take into account both sets of regulations at the same time, to avoid two implementations of similar systems and processes.

Collateral Management Workflow Overview

Flowing from left to right, Figure 2 shows the components of the complete margin call flow, available from new and existing platforms.

1. Valuation of trades and portfolio, in most cases something an individual rm must carry out
2. VM calculation: once valuations are received, calculation of the change in value of a portfolio from day to day, according netting sets
3. Sensitivities Reconciliation: A new approach from AcadiaSoft and NetOTC whereby firms deliver the sensitivity points for a trade, which are reconciled with the counterparty and aggregated to cope with structural booking differences. This means the process is clean beyond this as only reconciled trades carry forward into the remaining processes
4. IM calculation, which in future needs to be using a model approved by regulators according to the new regulations on un-cleared business
5. Call workflow / communication: the process whereby a call is delivered to your counterparty, to which they respond
6. Asset selection using eligibility rules applicable to each party and within the regulations
7. Asset valuation of securities
8. Custody according to the segregation rules
9. Dispute resolution, when the response to a margin call isn’t an unequivocal Yes!
10. Reconciliations of trades, cash flows, valuations or sensitivities
11. Default Management following the bankruptcy of a party, something only NetOTC provides, releasing IM assets rapidly to all customers of its platform

Platforms and Services

Clearstream

Clearstream are aiming at the legal problem, of putting in place many new Credit Support documents to cover all existing relationships caught by the new regulations. Their intention is to launch a documentation set which is multi-lateral, something you execute once for all counterparties. They are positioning their Triparty collateral management service (TCMS) as a foundation layer for meeting the regulations, handling the workflow functions once a call is agreed.

Their platform will coordinate a margin call, to ensure both parties at least agree a call is needed, but not necessarily to get involved in whether the amounts on the call reconcile. Once a movement of value is agreed, Clearstream can apply automated rules to deliver eligible assets, and if necessary substitute them when needed. They also ensure your assets remain segregated as required, and don’t get rehypothecated.

Clearstream accelerators include:

• Their multi-lateral legal infrastructure
• Implementation of the necessary rules for custody and segregation
• The whole Triparty service with asset selection, valuation and substitution
• Instruction matching, waiting until both parties have delivered their margin calls
• Settlement, 23 hours per day
• The Global Liquidity Hub, providing access to assets held in local custodians

Euroclear

Euroclear’s global Collateral Highway is an open global market infrastructure helping its users source and mobilise collateral across borders and time zones. Providing market participants with rapid access to high-quality assets at a time when collateral and liquidity are increasingly scarce, it is open to all collateral takers, givers and intermediaries. This includes CCPs, CSDs, central banks, supranationals, global and local custodians, investment and commercial banks and corporate treasurers. The Collateral Highway concept tackles the problem of fragmented pools of collateral locked away in different entities, geographic locations and time zones by helping users source and mobilise their collateral inventory – through the Collateral Highway entry points – rapidly, efficiently and optimally to meet multiple collateral obligations – through the Collateral Highway exit points.

DTCC-Euroclear Global Collateral Ltd

Through the DTCC-Euroclear GlobalCollateral Ltd joint venture, DTCC and Euroclear have joined forces to put in place an industry solution to address the challenges posed by the changing landscape, especially in the OTC Derivatives space. It is the first truly global collateral infrastructure, underpinned by the experience, robustness and scalability of DTCC and Euroclear. It will help automate and streamline post-trade margin processing of cash and securities, for all market participants, improving the stability and soundness of financial markets. The end-to-end solution is comprised of the Margin Transit Utility (MTU) and the Collateral Management Utility (CMU).

DTCC/Euroclear Margin Transit Utility (MTU)

The MTU powers the Settlement Messaging & Tracking service by enriching matched margin calls and the associated movement with the appropriate Standing Settlement Instructions (SSIs) and then creating two SWIFT messages (a deliver and a receive) sending them to the appropriate parties to facilitate margin movement. Once the collateral has settled, the MTU receives the settlement con rmations from the dealer and/or custodian and then notifies the counterparties of the confirmed settlement. These settlement status updates received back into the MTU from the settling parties (custodians, settling agents and self clearing dealers) are passed back to the counterparties either via a GUI or an electronic message for consumption into their internal systems.

The DTCC MTU is intended to provide ‘glue’ and the “view” between the two counterparties exchanging collateral. The service helps manage the complexity that comes from multiple counterparties, custodians, and settlement locations and streamlines the settlement process boosting the levels of straight through processing and reducing the number of collateral settlement fails. The service is agnostic to the settlement location of the collateral and the collateral type as long as it can be settled via SWIFT messaging.

DTCC / Euroclear Collateral Management Utility (CMU)

The Collateral Management Utility (CMU) sits within DTCC Euroclear Global Collateral Ltd and fully capitalizes on existing Euroclear Collateral Highway infrastructure and services. The CMU powers two services, the Inventory Management Service (IMS) which automates the mobilization of securities from a us- er’s DTC account to Euroclear Bank allowing the user to satisfy any collateral obligation (SFT or margin) in the Euroclear Bank triparty environment. and the Triparty Collateral Management Service (CMS) which allows participants to manage and optimize collateral in a triparty model and settle these triparty transactions on a DVP basis in real time within the core US settlement systems- Fedwire and DTC.

At its essence, the CMU is the infrastructure which connects European and US collateral pools, providing the market with cutting edge collateral solutions and ensures users’ assets will be optimally allocated and substituted to meet collateral obligations across businesses and settlement locations while reducing client’s back-office workload and operational risk.

Combined, Global Collateral will offer its users a consolidated view of assets, obligations and collateral flows, across locations plus all associated reporting.

AcadiaSoft

For some years now AcadiaSoft have been developing a web based platform to support the call & communication work ow components of collateral management. Their raison d’etre is to provide a better solution than using email and phone calls, by tracking the call process in detail and providing an audit trail of activity.

AcadiaSoft are extending their services to include margin calculation and dispute resolution to provide more of the components needed for the new regulations. AcadiaSoft are offering to calculate your IM using either the ISDA Standard Initial Margin Model (SIMM) or using one of the schedule based approaches from the US or EU (or as applicable). Firms will need to deliver trade sensitivities to AcadiaSoft from which the IM can be derived. A necessary part of this service is the ability to reconcile these sensitivities in order to avoid disputes.

Their service will provide a complete solution from initial margin calculation through to the call, but it remains your responsibility to then process the asset selection and margin movements, but does integrate with the DTCC MTU to coordinate messaging and reporting on asset deliveries. For users of DTCC MTU, this service will coordinate messaging and reporting on asset deliveries.

MarginSphere

MarginSphere is an online matching platform for margin activity. You match three main areas – the margin call, proposed collateral and interest. Simply put, each counterpart would calculate their margin and then load it to MarginSphere. Calls can be either matched centrally or within a client’s collateral management system. For centrally matched calls, the platform attempts to match and returns a match, mismatch or no match. Having agreed the call a counterparty needs to work out what collateral that needs to be delivered. Proposed collateral is matched and an ISIN instruction is generated and sent to the MTU.

Dispute Manager / Collateral Hub

A new service from AcadiaSoft is the Dispute Manager, intended to directly address key risks to firms in the collateral workflow. A new approach to reconciling portfolios is to receive a collection of sensitivities for a trade, enabling aggregation and matching between two parties. This overcomes structural issues with some trades or packages, and expresses the fundamental view of each party on the valuation of the trade. Buried within the capital rules is a major penalty for disputes, by doubling the Margin Period of Risk (MPOR), which the Dispute Manager aims to avoid.

The outcome of their service is to achieve alignment of the economics of a portfolio, calculate the Initial Margin, and assist firms in investigating why their economics may be misaligned.

Once combined with their existing messaging platform, this enables AcadiaSoft to offer most of the components needed to meet the new regulations, and partners with DTCC and their MTU to smooth over the settlement process.

TriOptima – triResolve Margin

TriOptima have partnered with AcadiaSoft to give customers another route to compliance. The original triResolve service is a dominant player in portfolio reconciliation, enabling firms to discover differences in the population and valuation of trades. By extending their services across the process, triResolve margin now provides firms with an integrated way to calculate VM, IM via AcadiaSoft, and automate the margin call process.

Like triResolve, the new margin offering is web-based which means rms only need to send CSA details in addition to the trade and collateral balance data in triResolve to get started and margin amounts be calculated. Automated margin calls are made through AcadiaSoft’s MarginSphere and disputed calls can be investigated by drilling down into the reconciled trade, CSA and collateral data. Collateral amounts can be pledged for the undisputed amounts automatically too, something which regulators specifically require in the future.

The strength of the portfolio reconciliation platform from triOptima means that linking the margin call process to this underlying tool, brings advantages. Other platforms offer reconciliation tools, but triOptima receive (allegedly) 9 million trade records per day from a large group of customers in the market. Asset movement can be automated through DTCC’s MTU when it is up and running but for now users can direct instruction to a system or service provider of their choice.

NetOTC (No longer in business)

NetOTC is a company who has been around for some years, and moved through more than one incarnation of services. Their current public offering “NetOTC Bilateral” aims to address the forthcoming margin rules but in a different approach than those above.

NetOTC requires users to submit the risk sensitivities of trades, enabling them to aggregate and match with counterparties. Once matched they will calculate IM but in respect of all parties on the platform, their words “Results in a single daily IM calculation covering all participating counterparties” – which means your IM settlement is one asset movement rather than one per counterparty.

An advantage of their approach is that risks are contrasted using the sensitivities before progressing into the remainder of the workflow, avoiding disputes later. Their approach to ‘disputes’ involves processing any differences as additional margin, with attribution tools, to mitigate disputed margin calls.

NetOTC avoids calling themselves a multi-lateral platform, as they aren’t a CCP/DCO in the conventional sense, but their approach to calculating and moving IM does take into account your trading positions with all parties on the platform, rather than a non-centralised bilateral model.

NetOTC also note that they promptly release IM assets in a synchronized way, upon the default of one of the platform’s counterparties. Clearly with a centralised approach to IM it is important that a default is handled quickly on behalf of all users.

NetOTC is the only platform in this paper which has any involvement with the default process, all the others leave handling that situation to the individual parties. By handling a default in a central way and releasing IM assets via a pre-defined procedure, it would appear that customers of the platform will benefit from a cleaner process compared to the bilateral approach.

CloudMargin

Launched in 2014, CloudMargin has built a comprehensive collateral management platform with the difference that all services are delivered over the internet, or “the cloud”. The founders are ex-Omgeo who wanted to explore the idea of a ‘no install’ approach with a low monthly access fee. Having built the core platform, CloudMargin have added integration partners for valuation (Markit) and margin calculation (OpenGamma) which enable a firm to remain inside the CloudMargin service for nearly all the workflow process.

For settlement CloudMargin integrates to custodians via SWIFT rather than having a single custody partner. CloudMargin also integrate with MarginSphere to communicate calls and offer dispute resolution tools. In comparison to other providers, CloudMargin doesn’t require firms to send in sensitivities, but works from portfolio trade data itself.

Behind the scenes they also advertise integration with Clearing Brokers, Trade Repositories, DTCC and other market utilities. Finally they offer standardised open pricing, based on the number of agreements bracketed into roughly small, medium and large groups. You can view their current fee schedule directly on-line here http://cloudmargin.com/pricing/ with the lowest price being $15,000 USD per year for up to 10 agreements.

Software packages

A well known route is of a software package to provide collateral management functions. In some cases they integrate with MarginSphere for calls and triResolve for reconciliations. They also have the benefit of providing nearly everything you need on one platform, and having years of investment behind them. Examples include packages from OMGEO, Murex, Calypso, Lombard, Misys, Sungard, & 4Sight (there may be others).

Choosing your platform

The second white paper explains an approach to planning and implementing the new margin rules, in summary your key decision criteria in considering any platform above, should include:

• Asset class coverage: OTC, ETD, Repo, Stock Loan
• Support for Cleared and Bilateral business?
• Calculation of IM using a model approved by regulators?
• Functional scope (such as the blocks on the diagram above)
  • Valuation
  • Call calculation
  • Methods of call communication
  • Asset selection and optimisation
  • Settlement integration
  • Dispute handling and resolution
  • Reconciliations
• Integration and implementation approach
  • Every solution above needs you to deliver data one way or another
  • And you will want back reports and status updates
  • Do you install the system? Access via the Internet?
  • Is it hosted by you? Or by the provider?
  • How quickly can you become operational?
• Industry integration
  • With AcadiaSoft?
  • With triResolve?
  • With custodians & settlement providers?
  • With confirmation platforms?
  • Support for message formats such as FpML
  • Trade valuations?
  • Asset valuations?
• Timing
  • How quickly can you become operational?

Road to Un-Cleared Margin in 2016 onwards

In our second paper we outline the challenges you may face, as well as solutions to be considered. In order to be fully ready for September 2016 and March 2017, we suggest that you start planning now. A smooth surface on the road is entirely achievable and we will attempt to point you in the right direction. Consider the following milestones as objectives for this year and use our guide to help you understand what will be involved.

This article (By Bill Hodgson & Nick Stafford) 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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