At last week’s American Leaders 4th Annual Collateral Management Forum in New York, Michael Barrett, vice president, global head of Collateral Management Services and Solutions at Genpact Headstrong Capital Markets, spoke about how the buy side is adapting to new collateral management needs. In some cases, asset managers are working directly with a technology vendor, others are outsourcing to their custodian, and Barrett also provided the example of a large asset manager who built their own collateral management system in-house for a better cost than they could find elsewhere, but this was mainly possible due to the capabilities of the firm’s staff. Overall, though, custodians could be in line for more outsourcing, and Barrett spoke with Global Custodian after his panel to discuss collateral management trends.
GC: Can you see more asset managers finding solutions on their own rather than through a service provider?
MB: The bigger ones have already made decisions and selected platforms to use. Some started out with a platform for OTC derivatives and are now moving more asset classes onto that collateral management platform...Often times the asset manager will issue an RFP, sometimes they'll go directly to a vendor. For example, a very large insurance company, because they're on other systems provided by their software vendor, they took the collateral management program as well.
GC: What makes a firm do that versus going through their custodian?
MB: Control. When you outsource, you'll have an SLA with your custody bank, and the custody banks have been very successful in this area, but there are firms that want to maintain control, because their front-office portfolio managers want it internal for reasons such as they want to be able to change portfolio strategies quickly without having to [involve] an outsourced provider. With outsourcing there could be timing issues, and so forth.
Another trend that’s occurring where asset managers want more control is in the securities lending space. Whereas before the asset manager would’ve let the agent bank manage the collateral and do a revenue split, the trend is clearly not that anymore. Now the trend is for the asset manager to hire somebody to put the assets out, but the asset manager is going to manage that cash reinvestment internally and keep the revenue.
GC: Does that require additional software in-house?
MB: They need to have something in order to be able to do it, but usually they've already got it because their portfolio management systems often have the capability to manage the cash.
GC: What's driving that trend? Why now?
MB: The asset managers get paid to manage money, so they might as well. Why give up half the revenue to a bank? Using the agent bank was just the way is done before; securities lending revenue was looked at as incremental revenue in those days. Now with margins so thin and interest rates so low, any incremental revenue adds alpha and increases where you rank among asset managers. If you can eek out an extra four basis points, that's good money in today's market.
GC: Aside from the securities lending space, will there be more collateral outsourcing overall?
MB: I think there's tremendous opportunity for the custody banks that provide those collateral services. Historically, other things have been outsourced like proxy voting and shareholder services. The buy side has been the leader in outsourcing operations so they can focus on investment management, which is what they do best. So this is just one more step that I see where custody banks are not only doing a good job but have the resources, the capacity and the platforms in order to be successful with this.
GC: Is collateral a little harder to outsource because it has more of an investment component?
MB: If you outsource end-to-end so that you outsource your agreement management, your margin call activity, your dispute resolution, and the collateral management aspects of this, and you have enough trust in your provider that they're going to do right by you, you can focus on the things you need to focus on, which are managing assets and making money. And the banks have stepped up. Since 2008, they’ve [adapted their businesses], such as Northern Trust buying the hedge fund administration business of Citadel (Omnium), State Street servicing hedge funds through their enhanced custody business, and BNY Mellon offering prime custody services...the [banks] have built services and products or tweaked services and products around the customer in order to better serve the customer.