Opinion Piece By Steve Everett, Senior Manager: Strate’s Collateral Management Services
A global demand for high-quality liquid assets, as a result of regulatory reform, may drive a change in the way that assets are used as collateral in each market. In order to obtain an understanding of these implications on the future collateral management landscape in the South African Market, advisory firm Deloitte performed an independent review of the current collateral management processes and practices to determine the potential impact on high-quality liquid assets due to the many regulatory changes to be implemented over the next three to five years.
In order to prepare an impact analysis of these regulatory changes, Deloitte investigated the current collateral management process within a local bank and assessed the risks and potential costs associated with how collateral is currently placed and received.
According to the study, they highlighted the following issues:
- The manually intensive nature of collateralising across exposure types such as securities lending and borrowing, over the counter (OTC) derivatives and repo transactions;
- The risk of ‘locking up collateral’ resulting from collateral ‘silos’;
- Margin and collateral valuation discrepancies between counterparties;
- Accurate and timely concentration risk management across organisational silos, where collateral received doesn’t breach group concentrations;
- The opportunity costs of placing predominately cash as collateral versus non-cash collateral;
- A lack of the necessary market standards and automation to efficiently manage non-cash collateral across counterparties;
- The surrender rights of posted collateral;
- An inability to accurately identify the location of collateral as well as the discovery that there are currently limited mechanisms in place which enable the tracking of collateral re-use; and
- Non-cash collateral moves on a T+1 basis, often with waiting periods for returns.
Their report, issued during mid-2015, analysed the potential future liquidity pressures expected from the beginning of 2016 as a result of the combined implementation of increased Basel III ratios, mandatory clearing of OTC derivatives, Solvency Assessment Management for insurance companies and increased margin requirements under a T+3 equities settlements cycle. These requirements are set to become more onerous year-on-year across the market for a variety of institutions.
The multi-billion rand question, ‘will there be enough collateral to meet these requirements from 2016 and beyond?’ The study echoes many other studies on this topic, in that there is probably enough high-quality collateral in the market to meet these requirements. However, collateral is often not used efficiently or at the best cost. As a market, these costs are not only isolated to banks, as these regulations will start increasing the cost of collateralised transactions across the board, making securities financing transactions more expensive.
Although collateral management arrangements are bilateral in nature between two counterparts, each counterpart will potentially have more agreements between themselves and other counterparts. Thus, all counterparts, and counterparts of counterparts, face similar challenges across exposure types.
Since this is clearly a market challenge, the market as a whole needs greater visibility of what collateral is available to be placed and received, as well as what collateral is available for reuse. The efficient mobilisation of the ‘cheapest-to-deliver’ collateral is essential to ensure the right collateral is placed against the right exposure at the right time and place. This requires a market-wide view of collateral along with market standards, increased automation and centralisation of collateral pools. This is the domain of a Tri-Party collateral agent.
Considering the current collateralisation issues and the anticipated challenges to collateralise in the near future, the introduction of a proven, world-class Tri-Party Collateral Service in the South African Market could prove essential. According to the study, the use of a Tri-Party agent, such as Strate’s Collateral Management Services, has the potential to achieve an increased efficiency of between 80% to 90% in managing collateral and a saving of between 20% to 30% in operating and funding costs through efficient market-wide collateral optimisation and mobility.
The inevitable requirement to increase the use of non-cash collateral will introduce a number of challenges, which are highlighted in the study. These challenges include the need for:
- Greater automation of collateral processes and procedures;
- The appropriate application of counterparty risk management (haircuts, tolerances, collateral triggers);
- The tracking of collateral placed and reused;
- Accurate collateral valuations;
- Management of concentration risks across asset types, issuers, sectors, duration etc.;
- Management of collateral substitutions;
- Efficiently optimising and mobilising collateral; and
- Real-time inventory management.
As the only active Tri-Party collateral agent in the South African Market, Strate’s Collateral Management Services is well positioned to manage these challenges, with its proven world-class systems and service, which facilitates both cash and non-cash collateral. Strate is the ideal partner to assist you in managing your collateral in this ever changing odyssey.