Collateral Optimisation – Don’t be dragged down

Since the global financial crisis, regulators have aimed to reduce systemic risk and increase transparency by expanding the use of collateral — the exchange of cash or securities to mitigate default risk in financial transactions. The collateral market is expected to continue to innovate and diversify in the future, driven by the ongoing demand for liquidity and efficiency.

The recent market stresses have highlighted the importance of developing and maintaining a collateral management capability, as it is essential to effective monitoring and managing of credit risk exposure, identifying counterparty stress and enabling optimisation of collateral inventories during periods of high market volatility. While financial institutions have shown noteworthy resilience, the recent heightened market volatility and margin call volumes observed due to the COVID-19 pandemic have exposed a significant number of vulnerabilities in the collateral management operations, technology and data infrastructure of institutions of all sizes on both the buy side and sell side.

Collateral optimisation is now the concern of both the back and the front office as funding costs and collateral based discounting should be incorporated in pricing before a derivative is traded. The key therefore to collateral optimization is knowing the legal, derivative and collateral position. Firms need to accurately analyze the demand for collateral, the available supply and how to make the delivery as cheap as possible.

Through the efficient use of collateral, linking to liquidity products and identifying of lending, financing and revenue opportunities, Alpha FMC can support the design and implementation of robust and flexible derivatives and collateral management operating models leveraging existing infrastructure and OMS platforms

Opportunities for transformation must be strategically assessed as there is no one-size-fits-all model.

1. Collateral optimisation involves modelling the real cost of your collateral, counterparty eligibility, concentration limits, and internal business constraints on inventory.
2. The key to collateral optimisation is knowing the legal, derivative and collateral position. You need to accurately analyse the demand for collateral, the available supply and how to make the delivery as cheap as possible leveraging “What if” and ”pre deal check” tools.
3.  It improves operational efficiency with automated and streamlined collateral allocation processes together with enhancing regulatory compliance by adhering to margin rules and reporting standards – the new market standard.
4. It brings numerous advantages to both collateral providers and takers, such as reducing funding costs with more affordable or accessible assets, increasing returns by reusing or reinvesting excess collateral, mitigating counterparty risk.
5. Netting of margin opportunities across multiple asset classes under a single or multiple LEI.

In summary, firms need to undertake a holistic review of capabilities to refine their target operating model which meets their strategic needs.

To learn more about how Alpha FMC can support your firm, reach out to Ajay Chavda