The industry has no choice. It must modernise, automate and optimise its processes or risk falling behind, market experts tell Sophie Downes
Collateral management was once viewed as the “ugly duckling” of the financial services suite, according to Gael Delaunay, global head of collateral management at Clearstream.
And much like Anderson’s fairy-tale classic, collateral has morphed into a captivating market player. Penned by Delaunay as “a fully-fledged trading activity driving profit and loss”, the service is now a vital aspect of the securities finance ecosystem.
Owing to its growing importance, it also warrants significant discussion. Amid rising interest rates, operational costs and regulatory pressures, a robust collateral framework is more important than ever.
Market evolution
The role of collateral management has undoubtedly evolved over the last two decades, as several leading industry experts highlight.
Adrian Dale, head of regulation and market practice at the International Securities Lending Association (ISLA), describes the humble origins of the service: “When I first started in securities lending, collateralisation of a loan was almost exclusively cash. Bonds were used occasionally, but not preferred, as it required more instructions and manual oversight.” Now, the diversification of collateral markets includes corporate bonds, equities and discussions of more glimmering assets such as tokenised gold.
David White, chief commercial officer at CloudMargin, also alludes to a simpler collateral market: “Pre-2008 and the global financial crisis, large chunks of derivatives market trading were uncollateralised, clearing was only in place on a small proportion of interest rate swap trading, and initial margin for bilateral trading did not exist at all.”
The impact of the 2008 crisis on collateral management is evident. Originally more of a back-office function, the economic crash prompted stakeholders to realise that they needed to better secure exposures, driving the initial commercial focus on collateral management. There have been a number of ways firms have adapted their services to accommodate this.
“Since the crisis, one key trend has been market restructuring to reduce systemic risk and improve resiliency,” remarks Todd Crowther, head of corporate development and collateral services at Pirum. “The second has been prudential regulations to reduce firm specific default risk, increase their backstops and boost the ability to better deal with stress events.”
Globally, the approach by regulators has been to introduce a number of initiatives including accelerated settlement, central clearing of more products and the implementation of margining for non-cleared OTC products. Growing the number of margin locations, products and participants, alongside reducing timeframes, has meant firms have needed to improve efficiency to comply with these heightened standards.
“Undoubtedly, we have a much safer market, and a huge amount of work has been done to get us to this point,” contemplates White. “These developments also underscore the incredibly important role that collateral management plays in the global financial landscape.”
Common Domain Model
The Common Domain Model (CDM) is one example of the industry associations’ attempts to increase standardisation among firms. The model, which provides a standardised way to represent transactions and collateral on DLT platforms, is vital to improving efficiency, Dale argues.
He alludes to multiple studies and developments in recent years regarding the post-trade process, driven by the Central Securities Depositories Regulation (CSDR) Settlement Penalty regime and responses to EU consultations. “We see the same conclusion again and again,” Dale divulges. “For the post-trade process to improve, there must be both a widespread adoption of technology and prescriptive standards.”
As the brainchild of the various industry associations, the CDM provides a consensus-driven standard that can be used between platforms and entities to standardise legal documentation. It can also apply that documentation to the inception and lifecycle management of both transactions and collateral.
There are multiple positives to adopting standards and technology, such as reduced costs and reconciliation breaks. Dale suggests a common standard could even be used to generate regulatory reporting — the biggest cost to firms according to a 2023 survey by the Value Exchange.
Benefits aside, there are practical, and necessary, reasons for standardising settlement. As Dale explains: “The EU regulatory community has told us, in multiple conferences, that if the market does not improve settlement performance, we will see changes to regulations that impose fines, mandatory buy-ins or other mandated tools.”
As regulatory pressures mount, the CDM offers a logical solution.
Regulation and innovation
Regulation and innovation are often portrayed as opposing forces as the industry evolves. I wondered if financial firms often had difficulties positioning themselves between the two.
When questioned on the challenges of balancing regulation and innovation, Clearstream’s Delaunay is remarkably measured. Compliance should not be viewed as a hindrance to innovation, he reasons, but rather as an opportunity — “it creates ideas”.
He is eager to point out the unique position of Clearstream within this balance: "As a central securities depository (CSD), it is true we are highly regulated. There are strict rules that we need to comply with.”
Again, he emphasises: “We do not see this as an issue, but as a way to make our business more robust and the industry safer.”
He also highlights the ways in which Clearstream, as a CSD, differentiates itself by offering unique services for clients. “We are the only CSD to offer cleared and uncleared repo for central bank money. This reduces the risk borne by clients on the triparty agent by settling their transactions on T2S,” he explains.
It is evident that, rather than stopping the firm from entering new spaces, Clearstream has found ways of operating within regulatory standards.
Cloudmargin demonstrates a similar pragmatism. “Regulation has to come first as regulatory compliance is non-negotiable,” states White. “However, what is important is that you build out and meet that regulatory compliance in the context of your broader overall strategy and vision. Successful regulatory compliance and innovation in collateral management are by no means mutually exclusive.”
Technology
How can firms achieve innovation? Speak to the fintechs.
For Broadridge, technology and artificial intelligence offer the opportunity to address pain points in the settlement process. Darren Crowther details Broadridge’s Securities Finance and Collateral Management (SFCM) platform that the firm has been focusing on for the last two years.
He describes the collateral utility they have created, which allows for a streamlined workflow, simplified UX and a single dashboard view of all margin call types across derivatives and securities finance collateral management. “Our flexible workflow approach has allowed for integration into the vendor ecosystems, providing a large degree of automation and reducing manual effort,” he comments.
Yet, Crowther is decidedly balanced in his appraisal of automation. Providing positive news to anyone still concerned about AI taking their jobs, he adds: “It is important not to lose sight of the basics of data quality. Poor quality data leads to weak decision making, and poor connectivity leads to low STP rates.”
Indeed, while technology is often used as a buzzword to connote modernisation, efficiency and success, multiple participants make a distinction between the promise of tech, and practical, working systems that actually deliver results. “You can have the best technology and the most sophisticated tools,” begins CloudMargin’s White, “but if they take years to implement, cost a fortune to run and cannot be modified without tremendous time delays and expense, it is pointless.”
He contemplates the vast amount of time and investment that CloudMargin poured into its cloud-based platform to make it flexible and cost-effective. “I believe if all vendors had this mindset, we would see a more efficient market,” he postulates. “Legacy technology that requires patching and upgrading has to be a nightmare we all consign to the past.”
Pirum’s Crowther offers a similar approach to the topic of technology within collateral management. One particular challenge the firm has found is encouraging market participants to adopt new solutions. “As with any driver for change, the decision is grounded in the return of investment where the payoff, cost, timeframe and risk must be compelling,” he remarks.
Yet the results speak for themselves. “Given the material cost and benefits of collateral optimisation, the widening impacts between efficiency and inefficiency is driving firms to embrace transformational change in the collateral space,” Todd Crowther explains.
Digitalisation
As regulatory standards develop, and technology improves, what can we expect in the future of collateral management?
“Trends wise: more regulation, more CCP flows and more consolidation or connectivity between the players,” says Delaunay. “It is an interesting time, especially in digital.”
Indeed, when questioned about the future of the collateral sphere, all of my interview participants alluded to one topic: digitalisation.
Todd Crowther states Pirum will be “leading from the front” in terms of speeding the adoption of new technologies such as DLT, AI, blockchain and tokenisation. He highlights the firm’s focus on marrying new solutions with the existing market infrastructure.
Broadridge’s Darren Crowther discusses the important role of the CDM in allowing AI tools to manage more of the remaining exceptions, which in turn “will further reduce operational risk and allow teams to add value back to the business in other ways”. For ISLA’s Dale, collateral management is only going to grow as an offering, with the rise of digital assets and advancing technology paving the way for new asset classes.
The choice is clear: adapt or fall behind.
“The industry has no choice,” warns White. “It must modernise, automate and optimise its processes — firms’ margins and effective risk management depend on it.”
