Risktech start-ups struggle to clinch big-bank contracts

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Start-ups are widely reckoned to have a one in 10 chance of survival. For start-ups in the field of risk management, the odds are probably a little worse: the field has all the withering mortality of the ordinary start-up, plus the special hell of being small, agile and captive to the sluggish metabolism of a big bank.

For now, it’s not stopping them. Hoping for a big payoff, this group of disruptors is looking to upend risk management with their products, addressing things from transaction monitoring and trade reporting, to IFRS 9 and model validation.

Read the full article on Risk.net

 

 

Top five trends in collateral management for 2018

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Collateral management has broadened far past simple margin processing; collateral now impacts a majority of financial market activity from determining critical capital calculations to impacting customer experience to driving strategic investment decisions. In this article, we identify the top five trends in collateral management for 2018 and highlight important areas to watch going forward.

The holistic theme driving forward collateral management is its central role in financial markets. Collateral has grown so broad as to make even its name confusing: where collateral can refer to a specific asset, the implications of collateral today can reach through reporting, risk, liquidity, pricing, infrastructure and relationship management. The opportunities for collateral professionals have likewise expanded, and non-collateral roles must now have an understanding of collateral to deliver their core obligations to internal and external clients.

We see a common theme running through five areas to watch in collateral management in the coming year: the application of smarter data and intelligence to drive core business objectives. Many firms have digested the basics of collateral optimization and are now ready to incorporate a broader set of parameters and even a new definition of what optimization means. Likewise, technology investments in collateral are starting to tie into broader innovation projects at larger firms; this will unlock new value-added opportunities for both internal and external facing technology applications.

Here are our top five trends for collateral management in 2018:

#5 Technology Investments

The investment cycle in collateral-related technology applications continues to grow at a rapid pace. Collateral management budget discussions are moving from the back office to the top of the house. And partly as a result, the definition of the category is also changing. Collateral management should no longer be seen as strictly the actions of moving margin for specified products, but rather is part of a complex ecosystem of collateral, liquidity, balance sheet management and analytics. The usual, first order investment targets of these budgets are internally focused, including better reporting, inventory management and data aggregation. The second derivative benefit of a more robust data infrastructure focuses on externally facing trading applications, including tools for traders and client intelligence utilities that provide real-time information and pricing for the benefit of all parties. This new category does not yet have a simple name, one could think of it as a “recommendation system” but regardless of name, this has become a major driver of forward-looking bank technology efforts and efficiency drives.

As large financial services firms capture the benefits of their current round of investments, they will increasingly turn towards integrating core innovations in artificial intelligence, Robotics Process Automation and other existing technologies into their collateral-related investments. This will unlock a large new wave of opportunity for how business is conducted and what information can be captured, analyzed, then automated, for a range of client facing, business line, internal management and reporting applications.

#4 Regulatory reporting

Despite being 10 years since the bottom of the great recession, regulatory reporting requirements for banks and asset managers continue to evolve. Largely irrespective of jurisdiction, the core problem facing these firms is aggregating and linking data together for reporting automation. Due to strict timeframes and complex requirements, firms historically relied on a pre-existing mosaic of technology and human resources to satisfy regulatory reporting needs. However, these tactical solutions made scale, efficiency and responsiveness to new rules difficult. The challenge of regulatory reporting is a puzzle that, once solved, appears obvious. But the process of solving the puzzle can create substantial challenges.

Looking at one regulation alone misses the transformative opportunity of strategic data management across the organization. Whether it is SFTR, MiFID II, Recovery & Resolution Planning requirements of SR-14/17 or Qualified Financial Contracts (QFCs), the latest initiative du jour should be a kick off for a broader rethink about data utilization. Wherever a firm starts, the end result must be a robust data infrastructure that can aggregate and link information at the most granular level. At a high level, firms will need to develop the capability to link all positions and trading data with agreements that govern these positions, collateral that is posted on the agreements, any guarantees that may be applied and any other constraints that need to be considered. Additionally, it has to be able to format and produce the needed information on demand. Achieving this goal will take meaningful work but will make organizations not only more efficient but also more future proof.

#3 Transfer pricing

As firms try to optimize collateral across the enterprise, it is critical that they develop reasonably sophisticated transfer pricing mechanisms to ensure appropriate cost allocations as well as sufficient transparency to promote best incentives in the organization. Many sell-side firms have highly granular models with visibility into secured and unsecured funding, XVA, balance sheet and capital costs. And in varying fashion these firms allocate some or all of these costs internally. But many challenges remain, including: how should all these costs be directly charged to the trader or desk doing the trade; and what is the right balance of allocating actual costs versus incentivizing business behavior that maximally benefits the client franchise overall. As we know, client business profiles change through time as do funding and capital constraints. There may be a conscious decision to do some business that may not make money in support of other areas that are highly profitable. Transfer pricing is evolving from a bespoke, business aligned process to a dynamic, enterprise tool. The effort to enhance transfer pricing business models continues to be refined and expanded.

Firms that embrace the next iteration of transfer pricing will achieve a more scalable, efficient and responsive balance sheet. This will include capturing both secured and unsecured funding costs, plus firm-wide and business specific liquidity and capital costs. Accurately identifying the range of costs can properly incentivize business behaviors beyond simply the cost of an asset in the collateral market. Ultimately, transfer pricing can be a tool to drive strategic balance sheet management objectives across the firm.

Functionally, implementing transfer pricing requires access to substantial data on existing balance sheet costs, inventory management and liquidity costs that firms must consider. Much like collateral optimization, the building block of a robust transfer pricing methodology is data. Accurate information on transfer pricing can then flow back into trading and business decisions to be truly effective.

#2 Collateral control and optimization

Optimization is evolving well beyond an operations driven process of finding opportunity within a business to an enterprise wide approach at pre-trade, trade and post-trade levels. Pre-trade, “what-if” analyses that will inform a trader if a proposed transaction is cost accretive or reducing to the franchise is important, but this requires an analytics tool that can comprehend the impact to the firm’s economic ecosystem. At the point of trade, identifying demands and sources of collateral across the entire enterprise extends to knowing where inventories are across business lines, margin centers, legal entities and regions. It also means understanding the operational nuances and legal constraints governing those demands across global tri-parties, CCPs, derivative margin centers and securities finance requirements.

In a simple example, collateral posted on one day may not be the best to post a week later; if posted collateral becomes scarce in the securities financing market and can be profitably lent out, it may be unwise to provide it as margin. A holistic post-trade analysis, complete with updated repo or securities lending spreads, can tell a trader about missed opportunities, leading to a new form of Transaction Cost Analytics for collateralized trading markets.

#1 Integration of derivatives & securities finance (fixed income and equities)

The need for taking a holistic approach to collateral management has led the industry toward significant business model changes. Collateral is common currency across an enterprise and must be properly allocated to wherever it can be used most efficiently. This means that traditional silos – repo, securities lending, OTC derivatives, exchange traded derivatives, treasury and other areas – need to be integrated. Operations groups that have been doing fundamentally the same thing can no longer be isolated from one another; the cost savings that come from process automation and avoiding operational duplication is too compelling.

On the front-office side, changes needed to impact trading behavior, culture and reporting to name a few are often very difficult to implement over a short period of time. Despite similar flows and economic guidelines, different markets and operation centers, even though all under the same roof, traditionally suffer from asymmetric information. To address this challenge a handful of large sell-side players have combined some aspects of these businesses under the “collateral” banner, sometimes along with custody or other related processing business. Others have developed an enterprise solution to inventory and collateral management. We expect that, more and more, management is seeing the common threads and shared risks involved. The merger of business and operations teams translates into a need for technology that can be leveraged across silos.

The business of collateral management is reshaping every process and silo it touches. While the trends we have identified are not brand new, they all stand out for how far and fast they are advancing in 2018 and beyond. Financial services firms that take advantage of these trends concurrently and plan for a future where collateral is integrated across all areas of the business will improve their competitive positioning going forward. To add a sixth trend: firms that ignore broader thinking about collateral management technology do so at their own peril.

This article was originally published on Securities Finance Monitor.
To download this article, please click here.

Revisiting the Importance of Inventory Management in Collateral and Liquidity

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In this article in Securities Finance Monitor, Transcend’s CEO Bimal Kadikar discusses the opportunities for more effective liquidity and collateral management – and the potential benefits to the bottom line. A solid starting point is inventory management whereby firms can match collateral to needs, improve front-to-back office communications and increase operational efficiency and compliance.

Access the full report on Securities Finance Monitor.
To download this article, please click here.

A framework for build, buy or network in a changing market environment

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Capital markets firms are faced with tough choices in their vendor and utility selection. But when should firms choose to partner with vendors, participate in industry utilities or insource development altogether? This article provides a framework for thinking through the options.

Capital markets have always been fast moving but seldom have the drivers of change come from so many directions at once.  Both buy-side and sell-side firms are contending with simultaneous pressures to comply with new regulations, find new ways to generate revenues and to cut costs. What makes this environment even more challenging is the interaction between these competing goals. Implementing new functionality to comply with new regulations is not enough; systems and processes also need to adjust to accommodate changes to business models driven by those regulations. New business initiatives have historically gone through due diligence processes of varying degrees of strictness and now need to satisfy control questions from the outside.  All this at a time when technology is evolving at a dizzying pace providing many options that were not viable until recently.

These challenges should not be perceived as all negative because the current environment presents many positive strategic opportunities. From established technology providers to the newest fintech start-ups, there is now an unprecedented choice of technology vendor options. There is a greater willingness than ever by firms to partner and develop industry solutions and to support, and in some cases create, new service providers. Meanwhile, at long last, the breadth of new functionality offered by these providers is matched by their depth of expertise. Solution providers frequently now offer not just “software” or a “service” but a complete solution package.

While capital markets players show increased willingness to turn to others for help in this challenging environment, there is also the recognition that the return on investment from internal technology resources needs to come from genuine differentiators in areas such as trading, data analytics, risk management and client interaction. In this world of both challenge and choice how can firms make the optimal choices without becoming stuck in analysis paralysis? At the most fundamental level they require a framework for deciding when to build, buy or network in collective enterprises.

Assessing internal capabilities

For a capital markets firm, the starting point for creating a framework is a realistic assessment of who they are, where they are going and what they are capable of. Some firms’ strengths may come from getting the basics right in areas such as operations or credit. Others may be innovators, creating new products, being the first into new markets or the first mover in the application of new technologies. Few, if any, firms can be good at everything and the effort of trying can be counterproductive. A realistic recognition of strengths and weaknesses is key.  This analysis needs to be conducted front to back ⎼ including business functions, personnel and technology capabilities ⎼ to ensure the most holistic understanding is developed for optimal decision making.

The next step is for a firm to understand where it wants to go, or more often in the current changing environment, where they need to go. Banks have been constrained by the pressure to build up and conserve capital. As a consequence, many formerly key business areas have shrunk or been closed. On the buy-side, active fund management, a traditionally high margin business, is under threat. Business changes such as the growth in popularity of low-cost ETFs and the rise of the robo-advisor are having major impacts on business strategy, even where the basics are sound. Whether a business strategy is expansive or reactive, or simply aimed at preserving a successful franchise, it has a major impact on a framework for interaction with technology and service providers.

Lastly, firms need to assess the potential of help from external parties versus the strengths of internal capabilities. One of the most significant recent developments has been the willingness to develop shared industry resources. The general driver for this has been a recognition that many parts of a financial sector organization (including the relevant parts of infrastructure) are non-differentiating sources of costs rather than sources of competitive advantage. Though industry utilities have been around almost as long as computers, they have tended to focus on a limited set of functional areas.

The new generation of utilities are appearing across front, middle and back office. Some notable examples include: FIS’s Derivatives Processing Utility which grew out Barclays; Accenture (in collaboration with Broadridge) Post-Trade Processing that absorbed business functions from Societe Generale; and more traditional projects such as Symphony, a collaboration of 16 major financial firms building a secure communication network. Another change of emphasis has been from the traditional regulatory drivers behind major utilities to more commercial drivers. In some cases, superior internal performance may actually create the opportunity for revenue generation by using that capability as the basis for an industry utility.

Creating vendor partnerships – dependencies, commodities and customization

There has been a high degree of consolidation of financial software vendors in recent years. Firms such as FIS have grown through a long-running series of acquisitions (notably SunGard at the end of 2015), Broadridge Financial Solutions continues to make acquisitions, and UK based Misys recently merged with Canadian D+H to form Finastra. Consolidation has also been driven to some extent by internal procurement departments, which in many large financial services firms have worked to reduce the number of vendor relationships.

Despite these trends, there has been little reduction in choice as new fintech vendor firms grow. “Innovation” or “digital” teams across capital markets firms have worked to build bridges to the more promising start-ups. Choice in functionality has been matched by choice in the type of offerings. Capital markets software is often now available as part of a comprehensive package including cloud-based hosting, integration and maintenance. Newer fintech firms may not be as big as other vendors but they make up for it with speed of execution, nimbleness and innovation in driving complex challenges. They are able to adopt some of the latest technology innovations much more efficiently than their larger counterparts.

Add to that the management of staff to execute the business process, and one end of the software services spectrum is indistinguishable from a utility. Still, partnering with a vendor creates the bane of any project manager: more dependencies on outside parties can mean more risks, the potential for slow turnaround and reduced control. The alternative, however, isn’t foolproof. Good internal development teams and working in genuine partnership with a business can deliver changes rapidly that are focused on a business user’s needs. However, writing new software or even carrying out the full integration of a vendor package can be a high risk and high-cost strategy.

A good amount of the current enthusiasm for partnering with new fintech firms or joining industry utilities come from few key factors:

  • The experience of difficulties rolling out new systems in financial firms’ increasingly controlled and complex environments.
  • Many fintech firms can offer significantly deep domain and technical experience that may not be available internally.
  • Many financial firms have difficulty in finding and retaining top technology talent as professionals have opted to pursue other opportunities in the broader technology industry or fintech space.

This can make it harder than ever to deliver a project to budget, with acceptable timescales and user expectations. Even where a firm shows expertise in one area of technology, it is unlikely to have breadth and depth of resources within its IT function to do everything to the same standard.

Commoditization or specialization

Depending on an honest assessment of the firm, its capabilities and business strategy, different choices may be made about buying, building or collaborating. If a capital markets firm’s need is for relatively standard, commoditized functionality, then the key factor becomes the gap between their offering and the firm’s needs. The wider the gap, the greater dependency on additional work being done and the greater the implementation risk. If a wide gap exists between the firm’s needs and the full range of offerings, it may be worth going back to basics and asking why its needs are so different to peers that make use of software packages or other services in the first place.

If one or more potential partners can provide the desired functionality, the characteristics of the vendors themselves need to be considered. Important variables will include vendor capabilities and skill sets in terms of business domain and technical innovation, reputation in the industry, and extensibility of architecture and offering.  Many large vendors provide full feature functionality but it may be hard to customize whereas some newer fintech firms are leveraging more flexible technologies to make their offering able to meet various needs. If a supplier can provide functionality that can then be extended by an internal team, it may be an advantage as firms don’t always need to rely on the vendor for critical business changes.

If businesses require more innovative solutions than they are capable of mustering internally, it is likely that a partner will be of benefit. But the characteristics of the partner may become the most critical factor. Any partner chosen needs to have a genuine understanding of the firm’s needs. Genuine understanding comes from the combination of both technical skills and real-world experience. Suitable partners also need to understand the value of building a solution that is not just for today but has the flexibility to adapt to tomorrow’s challenges. Regulatory changes, such as the requirement to report securities finance trades under SFTR and margining of FX Forwards as a result of MiFID II, can have dramatic impacts. On the positive side, market changes or the rapid uptake of a new product can still lead to dramatic increases in volumes. In this case, firms need to look for a partner and not just a vendor because they may be able to help them assess their current capabilities and also help define the roadmap based on their understanding of the industry and regulatory landscape.

Utilities will continue to provide their own unique solutions, but the vantage point of a buyer or user should be: “is this process sufficiently commoditized that a utility can meet my needs?” Any truly commoditized process can be outsourced to a utility, while processes that offer or require differentiation should be managed internally by the firm. Firms may also need to have internal capabilities developed in-house or through a vendor to connect to the utility and take full advantage of their services. Utilities have a lot to offer, but firms need to be proactive in making the decision about what is a competitive advantage and what is a commodity service.

Creating a framework for understanding a capital markets firm’s capabilities and comparing the results to the vendor and utility landscape is the first step in deciding whether to build, buy or partner for solutions in today’s market. The catchphrase of outsourcing is easy; the hard part is ensuring that firms are building flexible partnerships for the long term. At Transcend Street, we find having a great product or solution is a good start but not enough to win the long term partnerships.  Our clients reach out to us because of our team’s broad industry experience, thought leadership and our focus on execution and delivery. Our vision, its alignment for the client’s benefit, and our capacity to be a long term partner in their success is our crucial differentiating factor.

As technology becomes increasingly complex, it is imperative that firms conduct a holistic review of their own capabilities and strategically identify the right partners. Too often, firms focus on features and functionality comparisons across solution providers but not enough on critical internal assessments. In the brave new world, where profits are scarce, cost pressures are high and regulatory compliance is crucial, firms that can master this strategic balance of internal builds and strategic partnerships in the industry will have a significant competitive advantage.

This article was originally published on Securities Finance Monitor.

Building a Holistic Collateral Infrastucture

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Following the financial crisis, regulations and their associated reporting have created an opportunity for banks and investment firms to create a single, unified collateral infrastructure across all product siloes. This does not have to be a radical architecture rebuild, but rather can be achieved incrementally.

There are legitimate historical reasons why collateral infrastructure has grown up as a patchwork of systems and processes. For products such as stock lending, repo, futures or contracts for difference (CFDs), the collateral/margining process was generally integral to the products and processing systems. It would not have made sense to break out collateral management into a separate group and hence operating teams and systems were structured around the core product unit. Generally, only OTC derivatives had a relatively clear decoupling between collateral management and other operational processes. Even as business units merged at the top level, this product separation at the collateral management level often continued.

While this situation could stand during non-stress periods, the financial crisis demonstrated the fallacy that siloed, uncoordinated collateral management systems, data and processes could weather any storm. This disjointed view caused a number of specific problems, including: an inability to see the full exposures to counterparties; a lack of organization in cash and non-cash holdings; and substantial inflexibility in mobilizing the overall collateral pool. Even before the crisis, inconsistent or “zero cost allocation” for collateral usage meant that collateral was not always being directed to the parts of the business that needed it most. After the crisis, with collateral and High Quality Liquid Assets at a premium, this became unacceptable.

Today, few banks and investment firms have completed the work of integrating their collateral management functions across products (see Exhibit 1). Some of the largest banks are focused on building capabilities to achieve enterprise-wide collateral optimization, while others are just starting on this effort, at least on a silo basis. Some have bought or built large systems with cross-product support, although this has proven costly. Others are evaluating organizational consolidation. Whatever their current state, a new round of regulatory reporting requirements in the US and Europe means that letting collateral infrastructure sit to one side is no longer viable to meet business or compliance objectives without adding substantial staff. One way or another, long-term solutions must be achieved.

Exhibit 1: Moving past the siloed approach

Source: Transcend Street Solutions

 

The next round of regulatory impact

While nearly all large firms have digested the current waves of regulatory reporting and collateral management requirements, the next round will soon be arriving. Among these are the Federal Reserve’s regulation SR14-1, MiFID II (Revision of the Markets in Financial Instruments Directive), and the Securities Finance Transactions Regulation (SFTR). It is worth looking at some of these requirements in detail to understand what else is being demanded of collateral management infrastructure and departments.

The Federal Reserve’s regulation SR14-1 is aimed at improving the resolution process for US bank holding companies. It includes a high level requirement that banks should have effective processes for managing, identifying, and valuing collateral it receives from and posts to external parties and affiliates.[1] At the close of any business day banks should be able to identify exactly where any counterparty collateral is held, document all netting and rehypothecation arrangements and track inter-entity collateral related to inter-entity credit risk. On a quarterly basis they need to review CSAs, differences in collateral requirements and processes between jurisdictions, and forecast changes in collateral requirements. Also on the theme of improved resolution rules are the record keeping requirements related to “Qualified Financial Contracts” (effectively most non-cleared OTC transactions).[2] These require banks to identify the details and conditions of the master agreements and CSAs applying to the relevant trades.

While the regulatory intent is understandable, these requirements are exceptionally difficult to meet without a unified collateral infrastructure. There is in fact no way to respond without a single, holistic view of collateral and exposure across the enterprise. While SR14-1 impacts only the largest banks, it still means these banks have a mandate to complete the work they have begun in organizing their vast collection of collateral information. This will lead to greater collateral opportunities for the big banks, and may in turn encourage smaller competitors to complete the same work in order to exploit similar new efficiencies.

Article 15 of Europe’s SFTR places restrictions on the reuse of collateral (rehypothecation). The provider of collateral has to be informed in writing of the risk and consequences of their collateral being reused. They also have to provide prior, express consent to the reuse of their collateral. Even with the appropriate documentation and reporting in place, a collateral management department has to carefully ensure that the written agreement on reuse is strictly complied with. While nothing is written in the US yet, market participants believe that the US Office of Financial Research will soon require mandatory reporting that may entail overlapping requirements.

Similarly, MiFID II introduces strict restrictions on the use of customer assets for collateral purposes and potentially has a major impact on collateralized trading products. A complicated analysis must be conducted on best execution, but in OTC and securities financing markets, best execution may be a function of term, price, counterparty risk and/or collateral acceptance. Further, any variation from a standard best price policy needs to be documented to show how the investment firm or intermediary sought to safeguard the interest of the client.

SFTR and MiFID II require that banks rethink their entire reporting methodologies, and in some cases must rethink parts of their business model. A wide range of new information must be captured, analyzed, consolidated, and reported outwards and internally. This will likely generate new ideas and business opportunities around collateral usage and pricing for those firms that can digest the large quantities of new information that will be produced.

A holistic foundation for trading, control, MIS and regulatory reporting

The struggle at many firms to comply with regulations while maximizing profitability has led to two parallel sets of infrastructures: one for the business and another for compliance. This creates two levels of cost that duplicate substantial effort inside the firm. Along the way, business lines get charged twice for this work as costs are allocated back to the business. This is an immediate negative impact on profitability; even firms that have completed collateral optimization immediately lose a piece of that financial benefit.

The cumulative impact of regulation means that banks and investment firms generally cannot afford to wait for consolidation projects to deliver a single integrated platform. The fragmentation of teams, data and processes are hurdles for any institution to overcome but so is the old mindset that simply thinks of collateral management as an isolated operational process.

We identify five critical areas for firms to address in order to create a foundation for their holistic collateral infrastructure:

  • Map the full impacts of regulatory and profitability requirements on businesses, processes, and systems.
  • Recognize that collateral management is an integral part of many key activities at the firm including trading and liquidity management.
  • Understand the core decision making processes at the heart of effective collateral management.
  • Organize and manage the data that is required to drive those processes.
  • Build a functional operating model for collateral management.

The fifth recommendation, building a functional operational model for collateral, means being able to connect together disparate business lines to provide an enterprise view of collateral. It includes mining collateral agreements to make optimal decisions or decisions mandated by regulation. It requires the ability to perform analysis of collateral to balance economic and regulatory drivers, and it requires controls and transparency of client collateral across all margin centers.

At Transcend Street Solutions, we are actively working with our clients to help them develop a strategic roadmap of business and technology deliverables to achieve a holistic collateral infrastructure. While there are always organizational as well as infrastructural nuances in every business, we have seen the framework proposed above yield a positive return for our clients. Our technology platform, CoSMOS, is nimble, modular and customizable to accelerate collateral infrastructure evolution without necessarily having to retire existing systems or undergo a big infrastructural lift.

Getting this right is important for more than just regulatory compliance. It means the collateral function and trading desks can perform the forward processes required to support both profitable trading and firm-wide decision making. Pre-trade analytics is needed to ensure that collateral is allocated optimally across portfolios and collateral agreements. Optimization is also needed at the trade level to ensure the most suitable collateral is applied to each trade or structure. Finally, analysis needs to be carried out across the whole inventory of securities and cash positions to ensure collateral is used by the right businesses. After all, correct pricing of collateral across business lines is not only essential for firm-level profitability but also incentivizing desirable behavior throughout the organization.

We strongly believe that firms that are successful in achieving a holistic collateral architecture will have a significant competitive advantage in the industry. They will be able to achieve optimization of collateral and liquidity across business silos while meeting most global regulatory requirements, and all that with a much more efficient IT spend.

This article was originally published on Securities Finance Monitor.

An interview with Bimal Kadikar, CEO of Transcend Street Solutions

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“Transcend Street Solutions is establishing itself as an innovative player in the collateral and liquidity technology space. We spoke with CEO and founder Bimal Kadikar to learn more about what Transcend is doing and how it sees the evolving market.” – Josh Galper, Securities Finance Monitor

Read the full interview with Securities Finance Monitor

Collateral and Liquidity Data Management: the next big challenge for financial institutions

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The problem is well known: financial institutions have data all over the place. Small institutions tend to face straight-forward challenges, while large ones must identify not only where data are hidden but how can it be aggregated without disrupting other processes. Thankfully, new advances in collateral and liquidity technology are ready to make solutions cost-effective and relatively painless to implement.

Imagine these scenarios that require data:

  • Regulators are mandating reporting that looks at all assets of a corporation, both on and off balance sheet, across every subsidiary and geography. How does a central reporting group collect the information?
  • Sales traders and their clients are cautious about balance sheet charges. How can a sales trader tell a client about the netting opportunities in a trade compared to existing holdings?
  • Large institutions have recently created central collateral funding desks. How can a trading division know what collateral is available internally to commit to a counterparty and how much it will cost?

These are all situations where data aggregation and management can play a pivotal role, saving substantial time and effort and opening doors to enhanced revenue opportunities.

The Four Vs of Collateral Management Data

The obstacles to effective collateral data management today begin with the sheer volume and dispersal of data around the world. This is in some ways a ‘Big Data’ problem, albeit with industry-specific twists.
We see four Vs at work in collateral and liquidity data management:

  • Volume – the volume of data that must be managed reaches the gigabytes and terabytes for any financial institution of at least moderate size. The bigger the institution, the greater still the volume of information that must be captured and analyzed.
  • Variety – collateral and liquidity data do not come standardized in a pre-packaged format. Instead, users must contend with multiple forms of data that ultimately get combined to provide the right report or picture for taking action. This can happen with both internal and external data sources.
  • Velocity – data move fast, and every new trade in financial markets means that something has changed in an institution’s holdings, whether the value of stocks owned, the need for a collateral call or the credit limit of a counterparty.
  • Veracity – its great to have all data in one place but how can users be sure that the data are accurate? Users need a way to verify the integrity of data across the enterprise.

Four Vs of Collateral Management

Existing Solutions

While institutions have largely solved these problems for single business or legal entities in one legal jurisdiction, the problem is not close to being solved once the boundaries get beyond this limited scope. For example, getting US OTC derivatives to communicate with UK secured funding across different IT systems and countries can be difficult in silos, let alone ensuring that technology solutions work together.

The financial markets industry has recognized the difficulty of collateral management and is supporting initiatives and utilities meant to solve the problem. DTCC-Euroclear GlobalCollateral Ltd is launching the Margin Transit Utility (MTU), which aims to aggregate a firm’s holdings across all custodians and Central Securities Depositories. This is a great start, but even if all market participants and depositories agree to connect to the MTU, firms will need to integrate this information internally and feedback information externally. That will require a significant work effort across the board and even in the best-case scenario will take time.

Most technology providers also have excellent solutions for calculating data and managing positions but rely on the client to already deliver data internally. This is the same data problem once again: even the best collateral management system is made less effective by incomplete, unreliable data inputs. So, technology solutions need to evolve that allow connecting and harmonizing data across multiple silos more easily and without requiring major multi-year re-engineering efforts.

Case Study: Recovery and Resolution Reporting

While the problems inherent in daily trading operations are readily understood, the importance of collateral and liquidity data management grows even larger when considering regulatory reporting requirements. In one example, the Federal Reserve’s SR14-1 recovery and resolution plan reporting processes for banks highlights the critical need for robust data management. According to a January 24, 2014 supervisory letter, the eight largest US banks should have:

  • Effective processes for managing, identifying, and valuing collateral it receives from and posts to external parties and affiliates;
    A comprehensive understanding of obligations and exposures associated with payment, clearing, and settlement activities;
  • The ability to analyze funding sources, uses, and risks of each material entity and critical operation, including how these entities and operations may be affected under stress;
  • Demonstrated management information systems capabilities for producing certain key data on a legal entity basis that is readily retrievable, with controls in place to ensure data integrity and reliability; and
  • Robust arrangements in place for the continued provision of shared or outsourced services needed to maintain critical operations that are documented and supported by legal and operational frameworks.

Four out of five of these bullet points speak directly to data management. There can really be no question: it is not only a good business practice for banks to have active collateral and liquidity data management problems, it is also a legal requirement under SR14-1.

Case Study: Central Collateral Trading Desks

As collateral visibility, management and optimization have grown in importance due to regulatory and/or economic pressures, many large financial institutions are setting up central collateral trading desks/functions. Trading collateral has always been a fundamental part of dealer business but is usually done in silos such as repos, sec lending, OTC derivatives, prime brokerage, etc. The challenge of this new direction is that profitability has not grown at the same pace, which means that these desks may not have sufficient investments to build requisite analytics and technology. In addition, the centralization of bank services across operations and technology means that the needs of specific collateral types may get ignored in the event of a major technology renovation project.

A simple yet innovative solution to this problem is technology that serves as connectivity across all collateralized trading desks whether merged or in silos. Connectivity to repo, securities lending, OTC margining, futures, prime brokerage and other collateral-related business lines is critical to understanding both the big picture and the contributions of each business unit. By establishing this connectivity, firms can avoid major technology rebuilds or installs that may affect every trading desk in favor of middleware that provides data management as well as decision support across the organization.

By connecting all trading desks while leaving their product-specific technologies alone, firms can create a mechanism where data and analytics flow up to trading desks while decisions and actions flow down into the firm’s aggregate data pool. This creates a sizeable advantage for firms wanting to optimize their collateral trading activities while avoiding the cost and headache of a major technology project to harmonize platforms for data management.

The Transcend Street Solution

We at Transcend Street Solutions have considered the data problem across multiple large financial institutions in a new way. Many technology vendors seek to be the golden source of all data. We do not. Instead, we want to connect to every golden source of data where it stands now. This asks a financial institution to provide access to data and not replace existing warehouses or infrastructure. Our first solution, CoSMOS, collates, harmonizes, mines and analyzes all valuable information across enterprise-wide systems in real-time. We then feed those data into platforms for business user decision making, including regulatory reporting, internal applications and third party collateral management systems. By acting as an overlay, our goal is to quickly get the data out of storage and into a useful, actionable format.

Once the process of collateral and liquidity data aggregation is complete throughout the global organization and across business units, there are a wide variety of applications that can be brought to bear. We see regulatory reporting, insight on collateral agreements, funding and position management, margin dashboard management and liquidity analytics as starting places. We expect that the collateral and liquidity space will evolve to require additional services.
Uses of aggregated collateral and liquidity management data
Processing data for collateral and liquidity management is not an insurmountable task but it does take work. Many firms have only loose ideas about where every source of information is located internally across business units and geographies. But focusing on internal data aggregation enables a large number of other processes, reporting and technologies to function with maximum efficiency. The data problem is well-known: now solutions are appearing that confront the challenge in new ways.

This article was originally published on Securities Finance Monitor.