Winning the fragmentation battle


Businesses can strategically address their collateral and liquidity management operations and regulatory needs by adopting a more holistic integration approach, says Bimal Kadikar of Transcend Street Solutions

Financial institutions today are increasingly evaluating how best to manage their collateral needs in the face of dual challenges: adapting their business and operational structures to become more efficient and responding to and complying with ongoing demands around changing regulatory requirements. These issues resemble a seemingly impossible, task, like transferring passengers between two moving trains. Firms that approach front-office transformation challenges, decoupled from regulatory and compliance challenges, will miss opportunities to solve larger systemic issues in a strategic and integrated fashion. We strongly believe that technology strategy and architecture can play a critical role as firms meet these challenges.

Businesses can strategically address their collateral and liquidity management operations and regulatory needs by adopting a more holistic integration approach that takes into account their organisational complexity, unique business requirements and compliance mandates. Firms that get this strategy right will establish a competitive advantage and maximise limited budgets by significantly enhancing their front-office capabilities, while also meeting regulatory requirements.

Managing transformations and challenges simultaneously

Regulations are demanding significant changes to securities finance and derivatives businesses, which are primary drivers of collateral flow. An organisation’s overall portfolio mix dictates the cost of doing business, and having an integrated view of the complete liquidity situation is critical and can’t be done in isolation. These regulatory and economic forces are driving firms to integrate their collateral businesses that traditionally operated as silos.
At the same time, new global regulations are mandating that firms implement specific capabilities and requirements that are often quite broad, affecting many aspects of collateral and liquidity management capabilities. Consequently, these requirements are quite onerous to accomplish especially because they need to be implemented at an enterprise level.

What is required for front-office optimisation?

Typically, financial business units were structured and incentivised to take a highly localised approach to addressing the collateral requirements for their specific business lines. This historical constraint was driven by a need for domain expertise and reinforced by budgeting protocols and performance expectations that were more closely aligned with local returns on capital, revenue and income. In the current environment, making decisions within a single function misses the opportunity to achieve broader benefits to drive valuable optimisation across an enterprise. The outlying boxes in Figure 1 overleaf illustrate the standard, localised organisations that exist in most firms today, where individual business units make collateral decisions without consideration of their sister business’ needs.

Figure 1

Securities Lending Times

Firms that move beyond the silo approach and evaluate and prioritise collateral and liquidity requirements in a more integrated fashion across all of their collateral management processes are better positioned to ensure the optimal allocation of capital and costs, realise efficiency gains, and enhanced profitability. Some organisations are doing this by establishing collateral optimisation units that have a mandate to implement technology and organisational changes across multiple businesses on a front-to-back basis. Potential areas that organisations are evaluating include maximising stress liquidity, streamlining operational processing, reducing the balance sheet by retaining high-quality liquid assets (HQLA) and improving the firm’s funding profile by reducing liquidity buffers against bad trades for non-liquidity coverage ratio (LCR)-compliant transactions.

What is required for regulatory compliance?

While many front offices typically focus on creating optimal technology architecture to improve financial return metrics, there are specific regulatory-focused technology enhancements that additionally need to be implemented. In most cases, these regulatory requirements are implemented by compliance and/or operations areas potentially away from the front-office functions. This is a big challenge as these requirements are at the firm level and most firms don’t have a coordinated collateral architecture in the front. In particular, the US Federal Reserve’s recovery and resolution planning (RRP) requirements, qualified financial Contract (QFC) specifications in the US, and the EU Securities Financing Transactions Regulation (SFTR) are just a few examples that have pressing requirements and deadlines in the near future.

These regulations are creating significant demands on large institutions’ business and technology architecture:

• Track and report on firm and counterparty collateral by jurisdiction (RRP, SR 14-1)
• Track sources and uses of collateral at a security level across legal entities (RRP, 2017 guidance)
• Conduct scenario planning to simulate market stresses, such as a rating downgrade or other environmental changes, that estimate impact on collateral and liquidity position in stress scenarios on a periodic basis (RRP, SR 14-1 and 2017 guidance)
• Deliver daily information on their collateral and liquidity positions—specific QFC reports will cover position-level, counterparty-level exposures, legal agreements and detailed collateral information QFC specifications)
• Report on all securities finance transactions (SFTR)

To fully meet these compliance deadlines within the next 12 to 24 months, most firms do not have the luxury of adopting a strategic approach to reengineer their business and technology architecture and have been forced to take tactical steps to ensure compliance. However, it is likely that achieving compliance in a short timeframe will create huge business and operational overhead costs, as one-off solutions may not be tightly integrated and may require additional manual work and reconciliations over time. The ongoing need for changes to front-office business processes will have an impact on compliance solutions, potentially causing firms to significantly increase the operational overhead of supporting these businesses. This can lead to costs for collateral businesses significantly increasing, despite working hard to drive cost and capital efficiencies.

A better approach—holistic architecture

Firms that choose to tackle these operational and regulatory challenges head-on by investing to create and establish an integrated collateral architecture across business lines will have a significant competitive advantage. In a dynamic marketplace where business needs and regulatory requirements are constantly changing, a component-based architecture can be an effective approach. This allows seemingly complex processes to be managed through careful consideration of the distinct business and technology architecture elements of each stakeholder to achieve the appropriate balance for their strategy in an effective manner.

Figure 2

Securities Lending Times

Key components of holistic collateral architecture

Here are some important drivers to consider in your planning:
• Real-time inventory management capabilities across business lines that can be leveraged by both the front and back office (this is a critical component of the strategic architecture, with the key requirement of knowing firm, counterparty and client collateral by jurisdiction)
• QFC trade repository that is integrated across all securities finance transactions as well as derivatives trades that can be linked with positions, margin calls and collateral postings
• Harmonised collateral schedules/legal agreements repository
• Enabling collateral traceability across legal entities with the ability to produce sources and uses of collateral will ensure regulatory compliance, as well as the ability to implement appropriate transfer pricing rules to drive business incentives in the right places
• Utilising optimisation algorithms with targeted analytics can maximise a variety of different business opportunities and most importantly recommend actions through seamless operational straight-through processing

This transition can be difficult for firms as it will need to cut across business and functional silos and it can have significant people and organisational hurdles along with technology challenges. One key point is that these changes don’t need to happen all at the same time and firms can prioritise the approach in a phased manner in line with their pain points and priorities as long as leadership is behind the vision of the holistic architecture. Many firms have started this journey and those who can make demonstrable progress will have a significant competitive advantage in the new era.
Features
The latest features from Securities Lending Times
ESMA has set about tackling the thorny issue of conflict of interests within central counterparties under EMIR, with the help of industry participants. Jenna Lomax examines the industry’s responses to the consultation
For those on the front lines of the securities lending industry it’s easy to forget that, for beneficial owners, the trials and tribulations of regulatory compliance and the ever-raging debate around the use of central counterparties (CCPs) are only of passing concern
Join Our Newsletter

Sign up today and never
miss the latest news or an issue again

Subscribe now
Mirae Asset Securities (USA) is now operational in the securities lending, repo, foreign research distribution, corporate access and agency execution businesses.
Experts debate whether equities as collateral will ever be acceptable
Securities lending is a relatively low-return product, but any well-managed programme can be customised to mitigate the risks down to a level that justifies those returns, according to Simon Waddington of State Street
eSecLending is preparing to publish the third edition of its Best Practices for Securities Lending whitepaper. Here, the agent lender provides a preview
Lenders that have the ability to adapt their lending programme in line with the industry’s ongoing evolution can expect to be the biggest beneficiaries, says Sunil Daswani of Northern Trust
More efficient collateral allocations and better informed trading decisions are possible by improving visibility and understanding costs, says Pirum’s Robert Frost
Country profiles
The latest country profiles from Securities Lending Times
Zubair Nizami, head of Asian securities lending trading at Brown Brothers Harriman talks to Drew Nicol about the state of the industry in the region
Being an exciting emerging market is all well and good, but how long can that status really apply before interest wanes? India is doing its best not to find out
Asset Servicing Times

Visit our sister site
for all the latest asset servicing news and analysis

assetservicingtimes.com
Hugh Leonard, director of repo sales at Australia and New Zealand Banking Group, explains how the Australian market has excelled in recent years
Securities lending is in a strong place in Australia. Dane Fannin, head of capital markets in the Asia Pacific at Northern Trust, explains the available opportunities
Federico Ortega Gilly of Mexico’s Nacional Financiera explains why his country’s securities lending market is ripe for foreign investment
Russia’s National Settlement Depository has had a busy year making its securities finance market more robust and attractive to outside investors. The CSD’s Alina Akchurina explains the innovations being implemented
South Africa’s securities lending industry is on the verge of embracing a modern T+3 settlement cycle that could boost the country’s market
Experts on Canada’s securities lending industry discuss the market’s qualities compared to others, finding it to be a strong source of HQLAs
Interviews
The latest interviews from Securities Lending Times