Mastering margin


Euroclear’s Olivier Grimonpont reviews how new margin rules are forcing collateral managers to adapt, and how collaborative solutions are the answer

DTCC-Euroclear Global Collateral (DEGCL) is fresh on the scene. What does it offer your clients and what inspired this collaboration between two leading global market infrastructures?

Both DTCC and Euroclear recognised that the incoming regulation for over-the-counter (OTC) derivatives was going to increase the complexity for market participants who would be required to exchange collateral in a timely manner to cover the new margin requirements. That was the starting point for the creation of the joint venture between DTCC and Euroclear.

The market anticipated a considerable upturn in demand and foresaw a need to mobilise collateral on a previously unseen global scale—both from the perspective of the volume and different user segments affected as well as the geographical complexities. As market infrastructures, Euroclear and DTCC were among the first to see the scale of the challenge the industry would be facing.

Regulation was becoming the driving force behind the need for a more efficient exchange of collateral—both cash and non-cash—forcing market participants to link collateral inventories in the US, Europe and Asia, as well as establish connections between the buy side and sell side. To a certain extent this shift in operational model was already happening, but on a much smaller scale than the one the new regulation was about to impose on the industry.

In order to address those challenges, DTCC and Euroclear came together to build a combined utility-like solution based on their respective proprietary technology that would address the needs of the market and smoothen compliance with the new regulatory requirements.
The two core components of DEGCL are the margin transit utility (MTU) and the collateral management utility (CMU).

The MTU is a comprehensive, straight-through industry solution that automates and streamlines the processing, settlement and reporting of margin and collateral for dealers and buy-side firms. The MTU automates, by standardising and optimising a previously fragmented and manual ‘collateral settlement processes’, and minimises risk while improving efficiency. Specifically, the MTU provides straight-through processing for the duration of the collateral processing lifecycle, leveraging participants Standard Settlement Instructions (SSI) held in the DTCC Alert system.

The CMU introduced a new level of efficiency to support collateral management in both OTC derivatives and financing markets. Its suite of collateral processing and monitoring services automates the collateralisation of exposures arising from derivative transactions, as well as from repos and securities lending.

The CMU’s Inventory Management Services (IMS) enables the smooth mobilisation of US securities for further use in Europe through Euroclear’s Collateral Highway infrastructure that is available through Euroclear Bank.

The changing regulatory landscape has made it essential to efficiently allocate as well as segregate collateral across business lines and location. As more and more firms become involved in the posting of margin to cover OTC derivatives exposures, the scale of the task facing infrastructure providers becomes massive. As the rollout of the new regulations continues, we will eventually no longer be talking about 20 or 30 group firms talking to each other, but 1,000—it creates exponential challenges that will require increased collaboration from within our industry.

Going digital is an inevitable development in the markets evolution, how is this helping your clients?

Collateral management contracts are the starting point that define a firm’s triparty activity. It is essential to set them up accurately and maintain control of their structure so that, at any time, our clients can see what contracts they have out there—active or under negotiation. Euroclear moved the entire triparty contract management process into the digital age through our new front-end service, EasyWay Contract management.

EasyWay Contracts is an intuitive digital tool through which you can define, negotiate and manage your contracts through a single online portal, offering full transparency of all your contractual agreements. By enabling dealers to digitally negotiate, approve and sign their contracts, we are facilitating the negotiation between the parties, improving the turnaround time and substantially reducing the implementation risks. In other words, EasyWay Contracts ensures quick and accurate contract implementation with a clear audit trail and full transparency at all times.

Another benefit of moving the contracts into the digital age comes from the resulting standardisation of the eligible criteria. While still offering the necessary level of granularity required to balance risks versus return, digitalisation forces clear, unambiguous eligibility criteria, pushing for harmonisation and reducing misinterpretation of criteria. Having access to digital data also enables easier review of criteria, comparison
between sets and eventually providing better risk management data.

Is the EasyWay Contracts service already live?

Absolutely. The new EasyWay Contracts are available to our clients and I’m delighted to say that we’ve received excellent feedback. Most existing contracts are now visible through the tool and all new contracts are being implemented using the EasyWay contract management tool. We are definitely gaining traction in terms of onboarding triparty users onto EasyWay Contract.

From a number of bilateral discussions with clients, we have received very positive feedback and they really see the value of this solution. It’s an innovative step that clearly addresses what has traditionally been a really difficult and time-consuming process. In particular, I’m convinced that EasyWay contracts will be a key facilitator and differentiator when we reach the subsequent phases of implementation of the new margin rules.

DEGCL is not the only solution that’s come in response to regulatory demands. How will others, such as peer-to-peer platforms, affect the market?

New regulation has put a lot of pressure on banks’ traditional lending activities and we have seen some banks become increasingly reluctant to offer liquidity to non-banking entities because of what it means for their balance sheets. The disruptions in the repo market at the end of last year and, to a lesser extent, at the end of the first three quarters of this year, highlights the unintended consequences of some of the regulation on buy-side firms that have relied exclusively on banks to manage their liquidity.

Pension funds and asset managers are the ones that are likely to suffer most from this evolving trend and this will naturally lead to a process of seeking out alternatives, such as the use of peer-to-peer lending platforms, to manage their liquidity needs.

Peer-to-peer platforms, or rather all-to-all platforms, have an important role to play for the market and provide an alternative way for a market to manage its liquidity. While still in its infancy, the interest in these initiatives, such as Elixium to name one, is growing.

Once they have successfully attracted sufficient liquidity, from both buy-side firms as well as those banks willing to benefit from new pockets of liquidity available through this type of collateral exchange, there is little doubt they will be successful.

That’s not to say that peer-to-peer will solve all the recent liquidity issues we have witnessed, but it will become a key component in the financing toolkit that will serve to alleviate some of the restrictions and shortages we are seeing at the moment.

As peer-to-peer platforms become more prominent, one of the consequences will be the natural evolution towards greater standardisation within our industry to facilitate and encourage the participation of non-traditional counterparties such as corporates, asset managers and other buy-side entities.

How does Euroclear interact with peer-to-peer platforms?

Euroclear is an open architecture platform. We receive feeds from a number of sources, including peer-to-peer platforms, central counterparties (CCPs), and exchanges. I’ve often said that there’s room for more than one provider in this market. We have already established links with a number of very sophisticated platforms. We see these new and emerging platforms as a critical part of the market infrastructure going forward, so we are doing what we can to help them succeed by assisting them with the onboarding of clients, streamlining of their legal documentation and standardising their collateral baskets.

Looking forward, is increased standardisation the future of the market?

It has to be. Collateral is growing in importance and the number of participants involved in the exchange collateral is expanding.

Managing the huge number of relationships without a minimum of harmonisation, in terms of contractual and legal documentation, eligibility criteria, reporting, input channels and so on, will just become unmanageable from a cost or risk management viewpoint.

Creating a tailor-made eligibility profile for individual counterparties will probably continue to make sense for some of your activity. But for the rest, the use of mass volume collateral exchanges and increased standardisation will make much more economical sense.

Going forward, I think we’ll see new business becoming more generic, using standardised contracts and eligibility sets provided by either triparty agents, CCPs or peer-to-peer platforms.

Standardisation really is key. Euroclear developed a service called RepoAccess. This service enables a firm to sign one single legal document that gives them access to a community of dealers having all agreed the same terms. And the best thing is that our RepoAccess solution leverages the standards set by the International Capital Market Association for their global master repurchase agreement.

We are further expanding this to include similar services to support securities lending activity, leveraging the standards set by the International Securities Lending Association for the global master securities lending agreement.

I believe this is the future. Using industry approved standards to create a more automated and simple process saves firms time and money while reducing their risk. There’s a lot of work to be done but Euroclear is working hard to get it done.
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