Collateral Management Utilities Could Be Way of the Future

As the financial services industry looks to cut costs where it can, utilities models have emerged as a viable option, and these mutualized services could further emerge for collateral management, finds Celent.
By Jake Safane(2147484770)
As the financial services industry looks to cut costs where it can, utilities models have emerged as a viable option, and these mutualized services could further emerge for collateral management, finds Celent.

In its new report, Fortress to Federated Models in Collateral Management, Celent says that firms are likely to move away from in-house collateral management toward outsourced, cloud offerings and then longer-term toward utilities.

These technology changes also come at a time when collateral is becoming increasingly important across entire organizations, with Sapient Global Markets finding in a recent survey that the activity is having greater front-office implications.

“We’ve seen more investment in collateral infrastructure that’s not just a cost center or a back- or middle-office function. There’s recognition that it’s going to get pulled into the front office pre-trade because there are all kinds of implications that weren’t as important earlier when the margins were fatter,” says Randall Orbon, senior vice president at Sapient Global Markets. “Now it’s a place to optimize and make decisions about where to trade, with whom to trade, and what to use as collateral, and that requires different types of infrastructure that don’t really exist right now.”

Celent compares the collateral management industry to CRM (customer relationship management tools. In the 1980s, the report says, “in-house installed software deployment and systems integration costs were prohibitive, and ROI realization timescales were drawn out and unclear. With the emergence of SaaS-type platforms like, implementation routes to market took a radically different path. Alternative deployment models were speedier, with lower cost impact for clients who need ‘reasonable’ CRM capabilities without the prohibitive elements of traditional CRM vendors.”

Similar to how Salesforce changed CRM, Celent notes that cloud/SaaS collateral solutions are “offering more compelling price point advantages without necessarily sacrificing significant levels of functionality compared to in-house installations. Commonalities here include significant data integration efforts, operational activities involving multiple stakeholders and handoffs, use of unstructured data, and information that needs to be shared/utilized by various lines of business/divisions, with significant benefits to be gained from having a single view (if indeed, it can be achieved economically).”

Costs are certainly a concern, as an ISDA/Celent buy-side survey this year asked what two factors are influencing trading/investment economics and P&L most, with 53.3% saying margining costs/stringent collateral requirements, followed by 40% saying increased investment in control and compliance costs.

However, new cloud-based solutions are beginning to crop up, with Celent pointing out CloudMargin, which the company says can cost less than buying from technology vendors, outsourcing to a custodian /fund administrator or even running the process on spreadsheets.

Yet for many large institutions, internal collateral management remains the norm, with ISDA data showing that about 90% of all firms manage their collateral process entirely in-house, while 10% use a mix of internal and external means. With more cost pressure on the way, Celent thinks firms will shift to new operating models. But perhaps part of the delay has been the organizational challenge of deciding which route to take.

“There are so many stakeholders in the collateral management function, especially as it moves into the front office,” says Sapient’s Orbon. “I can imagine it’s hard to find one person you can point to and say ‘decide what to do,’ because it goes across asset class, the full lifecycle of the trade from front to back and the different parts of the bank. Due to this, it’s difficult to get a consensus.”

Beyond just cloud offerings, Celent points to emergence of “industry-level hubs” such as Arcadiasoft MarginSphere, which provides automated margin call messaging and confirmation, as well as the joint venture DTCC-Euroclear Global Collateral, which aims to link collateral pools.

“For differentiated or proprietary areas, firms could look to carve out, architecturally ‘componentize’ or ‘utilitize’ specialist functions, such as pre-trade margin queries and collateral optimization,” says the Celent report. “These could be internally or externally orchestrated, with the notion of sharing critical expertise, capabilities, or calculations through service- based interactions.

For less differentiating dimensions of the collateral management chain, firms could pursue scale and efficiencies of commoditized components of the value chain to business process and IT service providers.”

Ιn the longer term, Celent says end-to-end collateral utilities could emerge.

“The caveat for the successful development of market utilities for collateral management will require a coordinated effort by an industry majority, galvanized by the prospect of shared benefits,” says the report. “The key challenges are the competing interests of potential service delivery providers, the ability to unify operating model differences, and the initial spending commitment. As such, we see this scenario as something that is likely to occur in the longer term, when costs in other areas have been mutualized. How far the envelope can be pushed remains to be seen.”

For now though, Sapient’s Orbon notes, “There’s no system out there that you can just buy which will solve the problem. When it comes to technology vendors’ systems, “they all have credit risk modules, but those don’t take care of the core problem, which is: pre-trade, how do you make a decision?,” he says. “I think that’s still a critical issue for people to figure out.”