Cash-based collateral dethroned

In a world scared by the events of 2008, considerable questions have been put forward regarding the mitigation of counter-party credit risk, the protection and use of collateral, and greater demands on transparency within the financial services arena.

New regulations will be enforced to mitigate many of the risks in the greater market regarding capital adequacy and leverage, with Basel III, Solvency II, and Regulation 28 of the Pension Funds Act as examples of these regulations that will place a greater emphasis on the retention of liquid assets on the balance sheet of South African financial institutions.

The trend globally in response to regulations such as these has been to rather substitute high-quality liquid securities as collateral for cash as far as possible. As such, it is Strate’s belief that the same trend will apply to South African institutions.

Managing risk with collateral

management serviceCollateral is a key risk management tool in order to manage the liquidity of the greater financial system. Despite cash being a common form of collateral, some financial institutions in South Africa are already adopting the use of equities and bonds in addition to cash in the form of bilateral agreements.

However, the bilateral nature of collateral arrangements in South Africa brings with it limitations, such as the incomplete overview uncertainty relating to the location and size of the collateral, and how it can be traced throughout its movements.

The fungible nature of cash used as collateral brings with it uncertainty of recovery in the event of financial failure of the counter-party receiving the collateral.

Indeed, there are complexities when using securities as collateral…

The administration burden

Daily collateral calls, corporate actions, manual collateral substitutions, management of eligibility criteria, and collateral valuation contribute to a strenuously and manually-intensive administration process. Many institutions are finding the administration burden around collateral to be a costly exercise as a result, yet they will need to further invest in collateral management technology, capacity, and resourcing to meet the necessity to use securities as collateral in the future.

Can any of the institutions in the Financial Services market segment in South Africa invest in capital expenditure head count, on isolated proprietary and automated collateral management systems – which are not integrated to a greater collateral service for the Market – when the pressures on liquidity for the Market as a whole are intensifying?

According to specialist research and advisory firm in the securities and investments industry, Finadium, failure to effectively manage and implement effective and efficient collateral management systems could result in the loss of financial and revenue opportunities.

Collateral Management Service

Strate is launching its centralised, market-wide integrated collateral management service to complement current collateral management functions within financial institutions, aimed at improving the tracking and efficient use of collateral management in South Africa.

Strate will utilise the global Tri-Party Collateral Management services developed by Clearstream, the European supplier of post-trade services, which for the past 20 years has serviced more than 50 central banks, several commercial banks and lending desks as well as globally recognised CCPs.

Since 2011, Clearstream has offered the solution on an outsourced basis to CSDs outside Europe’s borders to countries that wish to use the service for their domestic market under their local authority’s jurisdiction.

The Tri-Party Collateral Management services can manage bonds, equities, money markets and other eligible asset classes in multi-currencies and is already operational in Brazil, with Australia and Canada following in the near future.

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