Collateral Management market context: Need for new ...

Collateral Management market context:

Need for new efficienciesEiFR Seminaire Paris, January 22nd 2014

Diane Nolan – Accenture

Copyright © 2014 Accenture All rights reserved. 2

Agenda

Collateral evolution: “Unlocking the potential in

collateral”

Future trends: need for new efficiencies


Market context – Challenge for Banks

Declining revenues & stubborn fixed cost bases are weighing heavily on IB

profitability, contributing to single-digit RoE across the industry

Securities markets are experiencing a continuing decline in volumes and

tightening margins

Investment banks are having to adjust to a new reality of tighter regulatory

controls and lower volatility

The cost of maintaining processes and technology to serve core functions

remains stubbornly high, despite targeted efforts to reduce the fixed cost base

through traditional means

Cost bases continue to be inflated by capital requirements under Basel III/CRD

IV and the burden of further regulation, including OTC derivatives reform

For some, high funding costs and insufficient returns will force them to exit

certain products

Other banks will use this inflection to aggressively restructure key businesses,

create sustainably lower cost structures and regain competitiveness


Over 30 new regulatory impacts alongside tighter interpretation of existing standards

Overview of current regulatory initiatives (international / EU)

Bank Regulations

• Basel III: Hybrid Capital Instruments, Definition of Capital, Capital

Requirements, Leverage Ratio, Liquidity Risk Management /

Liquidity Standards, Counterparty Credit Risk (CCR),

Countercyclical Measures, Systemically Important Financial Institution

(SIFI), Living Wills, Single Rule Book

• Capital Requirements Regulation (CRR) / (CRD IV)

• Basel III.5: Fundamental Review of the Trading Book

• EMIR: Central clearing of OTC derivatives and reporting

• EBA: Stress Tests

• Dodd Frank: E.g. Volcker Rule, Legal Entity Identifier (LEI), OTC

Regulations, Swap Pushout Rule etc

• BCBS IOSCO (Margin Requirements) as of Sept 2013

Taxation

• European Financial Transaction Tax (FTT)

• FATCA – Foreign Account Tax Compliance Act

• Double Tax Agreements (DTA)

Investment Service Regulations

• MiFID II / MiFIR – Markets in Financial Instruments Directive

• Packaged Retail Investment Products – PRIPs

• UCITS V – Undertaking for Collective Investment in Transferable

Securities

• ESMA consultation on the amendment of the UCITS framework

(UCITS VI)

• AIFMD – Alternative Investment Fund Managers Directive

• Regulations on Credit Rating Agencies

• Prospectus Directive

Capital Markets / Settlement / Collaterals / Payments

• Directive on securities transaction settlement in the EU and Central

Securities Depositories (CSDs)

• Target 2 Securities (T2S)

• Collateral Central Bank Management (CCBM2)

• Single Euro Payments Area (SEPA) Migration

• Regulation of the European Parliament and of the Council on Short

Selling and certain aspects of Credit Default Swaps

• New Market Abuse Directive (MAD)

• Securities Law Directive (SLD)

Accounting / Financial Reporting

• IFRS 9 – Financial Instruments (Replacement of IAS 39)

• IFRS10 – Consolidated Financial Statements

• IFRS 13 – Fair Value Measurement

NOT EXAUSTIVE

Source: Accenture Research

Regulation has become one of the biggest cost contributors

within banks today


Collateral evolution “Unlocking the potential in collateral”

Key themes of 2011 paper:

• Paper looked at key challenges of the Collateral

‘market’

• Sized the market as it stood in 2011:

• Size of collateral market estimated at

€ 10.215 trillion (excluding cash)

• Outlined the post crisis need for renewal of

business model and processing platforms

• Identified & quantified internal inefficiencies due

to organisational and governance challenges

• Cost of inefficiencies – 4 billion annually

• Identified external inefficiencies, in addition to

regulatory pressures, as largely due to market

fragmentation and custodian network complexity


Sizing the Collateral Market

Total value of securities being used in the collateral market

estimated at least € 10.215 trillion (excluding cash)

Source: Accenture Research

Unlocking the potential in collateral


Valuing the inefficiencies

Inability to maximise liquidity, lower the

cost of and lengthen tenor of funding

Maintaining excessive levels of collateralisation at Settlement agents

EUR 3.80 billions EUR 0,40 billion

Other external inefficiencies

Not quantified

Other internal inefficiencies

Not quantified

INTERNAL EXTERNAL

Cost of inefficiencies in excess of EUR 4 billion annually


Internally driven Impacts

Manage Collateral

Centrally

Single Collateral

Inventory

Internal transfer

pricing mechanisms

Tra

nsp

are

ncy

Simulation and

inventory projection

Optimisation

strategies

Sophisticated

optimisation engines

Op

tim

isati

on

Cost control

Aligned internal

governance

Changed Treasury

Function

Op

era

tin

g M

od

el

• Inability to get full overview of all

existing collateral

• Accurate and frequent information

on their entire collateral inventory

• Issues originating primarily from

internal politics and ineffective

operating mode

• Inability to manage collateral centrally

(or at least across collateral pools

• Lack of mobility of assets in order to use

different asset classes across different

business lines

• Unclear rules in governing the available

collateral

• Lack of internal pricing mechanisms

• Increased scrutiny within universal

banks, requirement for collateral

systems to be capable of identifying

and distinguishing asset classes for

the purposes of pricing collateral

• “Collateral Value” of a security

• Allocation Methods

• Collateral Utilisation Strategy

• Inability to perform inventory

projection

• Optimal collateral management

requires a forward looking approach,

meaning, sophisticated forward

looking exposure management >

collateral management decisions

• Use the tools that are there more

effectively

• Unavailability of optimization engines

or inability of deploying them

• Prohibitive investment

• Suboptimal internal governance

leading to misalignment of objectives

• The financial crisis worked as a

unifier leading to empowerment of the

group Treasury and increased focus

on liquidity matters

• Excessive staff costs die to

complexity of processes &

redundancy of transactions originated

by fragmentation

• Excessive IT costs due to multiplicity

of interfaces with external providers &

various internal pools

• Excessive legal costs due to

multiplicity of contracts with multiple

providers

• Emergency of collateral as a front

office function, creating greater

proximity to Treasury

• Influence on treasury in overall

liquidity management not sufficient

and not aligned


Externally driven impacts & Key Trends

OTC-CCP Client Clearing Collateral Segregation

Cross-Product Margining

• Offering Collateral Transformation,

consolidated margin calls and reporting

across cleared/uncleared trades to

reduce operational and funding costs

• Intraday margin calls from CCPs

• Changes to trade booking models as a

result of CCP connectivity & IM/VM

• In the OTC Cleared world clients pushing for

full segregation of collateral from that of

their clearing brokers/.other clients

• CCPs trying to differentiate themselves

through segregation offerings e.g. Eurex

• In Bilateral world BCBS/IOSCO and DFA

imposing segregation of initial margin at

third parties for uncleared swaps

• Cross-Product/Legal Entity

• Integrated view of counterparty

exposures across products traded

• Sharing of collateral pools across

cleared asset classes

Mark

et R

esp

on

se/T

ren

ds

Dodd-Frank/EMIR Basel III

Dispute Resolution

Protocol

Electronic

Messaging

Glo

bal R

eg

ula

tion

Ind

ustr

y S

elf

-Reg

ula

tio

n

Init

iati

ves

• Gradual transition of some CM-related

activities to FO to manage return on risk

• Speed of credit charge calculation as

differentiator to win new business

•Inclusion of collateral terms/funding P&L to

FO trade pricing models to provide more

competitive client quotes

• Improving the automation, security,

audit trail of collateral calls

• ISDA Best Practices Paper Feb 2013

• Acadiasoft Messaging Platform/

SWIFT FileACT connectivity

• TriResolve margining/e-messaging

• Integration of messaging protocols

with existing Collateral systems

• Revised DRP draft

• Portfolio reconciliation minimum data

standards

• Portfolio reconciliation process

definition

• Strengthened capital requirements for

counterparty credit exposures arising from

derivatives, repo and securities financing

• Incentives to move OTC contracts to CCP

• increasing need for liquid, high grade assets

• Liquirity Risk, LCR, NSFR

• Incentives to strengthen risk management

of counterparty credit exposures

• Incentives to move OTC Derivative

contracts to central clearing via CCPs

• Establishes minimum capital and

initial/variation margin requirements

• Near-real time reporting on Trade

Collateralization status

Standardised CSA

• Standardised Collateral Agreement to

eliminate valuation disputes in multi-

currency derivatives trades

Collateral Optimisation• Automated Algorithm-based Collateral

Allocation considering available assets,

obligations, constraints & real-time data

• Scenario Analysis, Stress Tests

Triparty Agents• Clearstream Liqiudity Hub /Euroclear Liquidity highway

• New players with T2S: BONY,JPM, BP2S collateral

Collateral as Revenue

Generator


Agenda

Collateral evolution: “Unlocking the potential in collateral”

Future trends: need for new efficiencies


Focus on Collateral Optimisation

Both investment banks and their clients are focusing on optimisation to

ensure their collateral assets are deployed efficiently

Collateral management is moving further towards the front office: from trade

enablement (securing transactions and mitigating risk) to an integral part of front

office decision-making (trade pricing, funding decisions)

Collateral optimisation is a big part of this change, matching available assets

with counterparty exposures and margin requirements in the most efficient way

possible

The “optimal” usage of collateral is subjective and will vary from firm to firm, so

optimisation strategies need to be tailored according to the profile of the

institution – if achieved successfully, optimisation is as relevant to the buy-side

as it is to investment banks

To manage collateral optimisation successfully requires significant investment in

technology – both in the engine and algorithms used to calculate the optimal

placement of collateral, but also in the provision of accurate and granular data

across various siloed products and functions to feed these calculations


Some progress on resolving ‘Transparency’ of Collateral usage

but limited progress on real ‘Optimisation’

Several considerations need to be looked at in order to “optimise” collateral

“Collateral Value” of a security

Existing allocation & exiting inventory (including pooling of collateral)

Haircut

Concentration limits

Operational cost

Allocation Method

Top up vs Rebalancing

Numerical / Linear optimisation

Heuristic / Ranking-based models

Simulation ability (incoming positions, cost/benefit of rebalancing, “What if”-analysis)

Collateral Utilisation Strategy

Avoid fails, e.g. no fails with central banks

Maximise liquidity, e.g. get most cash out of the available securities

Minimise movements

Moment of time during the business day


Since the 2008 crisis, Accenture has launched an annual flagship Capital Markets publication:Accenture’s Top 10 Challenges for Investment Banks

The publication is now entering its 6th year…

2009 2010 2011 2012 2013 2014

The publication provides a thought-provoking view on the key operational challenges for

investment banks in the year ahead

Interesting to note that Collateral management has been a constant feature each

year...and yet again in 2014…

04

TOP10 2014 – Challenge 4 - Building Sustainable Funding: Managing collateral & liquidity

• The demand for high-quality collateral is growing while the supply of eligible securities is

shrinking

• Investment banks must embrace enterprise-wide collateral optimization to reduce their cost

of funding and better manage liquidity requirements;

• High performers are developing new revenue streams with collateral offerings for their

clients


Top 10 Challenges for Investment BanksChallenge 4: Building Sustainable Funding: Managing collateral & liquidity

• The demand for high-quality collateral is growing while the

supply of eligible securities is smaller than ever before;

• Investment banks must embrace enterprise-wide collateral

optimization to reduce their cost of funding and better

manage liquidity requirements;

• Optimization technology, integration with end-to-end

processing and enhanced reference data capabilities

represent a significant technology investment;

• High performers are developing new revenue streams with

collateral optimization offerings for their clients.

Significance as a challenge for 2014

• Under Basel III capital requirements, the cost of funding is

becoming a closely examined metric;

• Liquidity Coverage Ratio (LCR) requirements need to be

carefully sized and closely managed.

Highlights

For discussion…

• What are the implications of

collateral constraints with

collateral management and

global treasury?

• How do you see the

interaction between these

functions (per line of business)

• How are Basel III

requirements (including LCR)

in the context of collateral

impacting your organization?

• How effective are Off-the-shelf

collateral optimisation

solutions available in the

marketplace for your needs?

04


A range of options are available to bring Accenture Capital Markets materials to you

Hard copies available

upon request Download PDFs of the

papers

Watch videos with industry

experts

Clients can directly request

a meeting with the author

Access the

challenges on

the move

1. Printed Papers 2. Microsite 3. Mobile Site

Top 10 challenges All CM publications

4. Cap Mkts iPad App

• All current Capital

Markets thought

leadership.

• Install the app on your iPad:

https://itunes.apple.com/ng/a

pp/accenture-library-for-

financial/id506276917


Thank you

For any questions or queries on publications, please do not hesitate to

contact me:

[email protected]

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