A recent DTCC whitepaper found that the combination of significant costs, risk and operational challenges linked to managing margin requirements have made financial institutions wary of fragmented approaches to collateral management. Mark Jennis spoke to Global Custodian about how the findings of the white paper served to inform the thinking behind the company’s new collateral management service.
What was the background to the white paper?
MJ: Our analysis began during Sibos 2013 when we developed a series of papers following conversations with dealers, the buyside and the custodians. What transpired was that the industry was heading in the direction of looking at the challenge of collateral in a fragmented way rather than a holistic one. Market developments in a way went against what the industry was increasingly calling for – a holistic approach and solution to the multiple challenges and risks associated with collateral management. So the white paper analyzed not only collateral optimization challenges but also challenges in terms of record keeping and reporting, exposure calculation and margin management, portfolio margining, communication standards and reference data as a way of understanding the scale of the collateral challenge. .
The white paper mentions projections on rising margin calls running as high as 1000%. How is that number derived?
MJ: There are two different analyses which led us to this finding: one was by working with OTC market participants and examining issues such as the growth of clearing houses, and regulatory changes under Dodd-Frank and EMIR requiring initial margin for both counterparties and the possible removal or reduction in thresholds. The second step was based on empirical evidence given to us by a large sample of the dealer community and their internal estimates. While these two steps were a good starting point, we are also funding an academic study by the London School of Economics (LSE) to review this issue. The results of the LSE survey are due to be announced in March.
What is the ideal solution for collateral optimization?
MJ: We believe that collaborative solutions should be employed to address collateral management challenges. One example is the approach we have taken with our Margin Transit Utility, where we are working with custodians, SWIFT and other providers to produce a solution that manages risk and meets regulatory requirements, provides scale – given the significant margin call and settlement volumes – and creates more efficient funding due to greater transparency. Looking at the nexus between counterparty risk, operational risk and liquidity risk, this solution primarily addresses lack of timely and complete information regarding the margin call and settlement process and the high rate of settlement fails.
Margin Transit is really about STP of margin and involves collaboration with dealers, custodians, buyside firms and various solutions providers. Those are the kind of holistic solutions the market has been calling for.
Is the collaboration specifically meant to look at costs, or risks for those institutions?
MJ: The answer is both. Some drivers are linked to the need to reduce costs: there remain many manual processes in use across the board from faxing settlement information to making margin calls, to settling disputes. But the other drivers are linked to transparency and risk mitigation, namely being able to get a real time view of the collateral movements. Transparency not only benefits firms from a regulatory standpoint, but it also helps them optimize the use of their collateral, which can reduce their funding costs.
Risk mitigation is a key driver. The challenge we are seeing is that some of the risk is moving from counterparty risk to operational and liquidity risk. We are seeing a lot of interest in the way in which operational risk can be mitigated to prevent other forms of risk e.g. addressing manual processes, lack of information, and settlement fails.
What makes you different to the other providers with collateral management solutions?
MJ: Our solution aims to minimize operational risk, create scale and reduce costs. Our solution is not only focused on the supply of collateral but also the ability of firms to effectively and efficiently manage their margin calls globally. Our premise is that there are many elements to the collateral challenge, but that focusing on the key processes and addressing them in a way in which creates scale and efficiency on a global basis is essential.
GC Friday Interview: Mark Jennis, Managing Director, Strategy and Business Development, DTCC
A recent DTCC whitepaper found that the combination of significant costs, risk and operational challenges linked to managing margin requirements have made financial institutions wary of fragmented approaches to collateral management. Mark Jennis spoke to Global Custodian about how the findings of the white paper served to inform the thinking behind the company’s new collateral management service.
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