Financial industry will need to tap USD100bn of idle or unrecognised assets to address collateral shortfall

Collateral management

The global financial industry will need to find almost USD100 billion in additional collateral to support the demands of the increasingly sophisticated collateral management ecosystem that has emerged in the wake of EMIR and Dodd-Frank, according to a new paper by Capco, a global management and technology consultancy.

An estimated USD97 billion in previously untapped assets will be required to meet current and emerging collateral requirements, including the adoption of two-way initial margin (IM) capabilities – which alone accounts for USD60 billion of the shortfall – along with enhanced capabilities to meet the need for IM for cleared trades, pre-funded variation margin, segregation requirements, default fund contributions and tighter collateral eligibility.

James Arnett, Partner at Capco, says: “We have already seen a big spike in collateral requirements in recent years, forcing firms to seek out new sources of high-quality liquid assets within their inventories and via external channels. A range of factors mean that the supply of eligible collateral is continuing to tighten and as a result borrowing costs are still trending upwards. So while firms still need to focus on efficiencies and optimisation, they will also need to tap previously neglected or unrecognised pools of collateral.”

Financial firms have started breaking down silos and with the assistance of cutting-edge technology and business collaborations have come a long way - but to attain collateral nirvana, much work still needs to be done. 

“Whilst new industry partnerships and a greater level of automation may alleviate some of the stress, the growing volume of margin calls, an increased demand for high-quality liquid assets, greater market fragmentation and regulatory burdens will all crank up the pressure on fractured processes, inflexible systems and a lack of cohesions through the value chain,” the paper notes.

In order to remain compliant, competitive and efficient, firms will need to prioritise a number of focus areas. These include potential buy-side impacts, notably around resources, in-house experience and operational ramifications. Ensuring technology is fit for purpose is another, as is addressing a lack of straight-through processing around legal documentation, specifically client service agreements.

Other key pain points include the calculation of valuations and exposures; margin call processing; collateral optimisation and segregation; trade reconciliations and dispute resolution; settlement processing and fails management; and reporting and record-keeping.

The sourcing of eligible assets, the blending of margin costs into execution price, and the ability to adapt to multiple regulatory regimes are also covered in the paper.