Centralized collateral management becoming a reality

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Collateral management has transitioned from an ancillary service to a core competency, largely as a result of the sheer breadth of activity from front to back office and horizontally across silos and asset classes. This has spurred a marked shift towards centralization of collateral management, providing organizations with a centralized view of inventory as well as funding and collateral optimization decisions.

But the move to a more efficient and centralized model is not without challenges. Inefficiencies and the cost of errors are magnified by the multiplicity of internal and external relationships that need to be managed and the requirement to control positions more frequently, even in real-time.

This requires a fundamental shift from managing assets only for margin purposes to managing assets for value, cost and balance sheet purposes.

Moving to a centralized collateral organization is a difficult step for many reasons and as a result, some firms are decoupling their business organization from their technology capabilities.  They are instead focusing on building a centralized, horizontal technology strategy for inventory and collateral management.

In either case, the end goal may be the same – a holistic infrastructure that can yield the benefits of centralized collateral and inventory management coupled with sophisticated analytics and firm-wide optimization capabilities. Fortunately, today’s technology enables this ultimate goal as well as the smaller moves in this direction.

Steps to collateral optimization

Regardless of the approach taken, there are a number of best practices for firms looking to increase the efficiency of their collateral and liquidity management:

  1. Achieve visibility into inventory across multiple business lines and regions. This centralized view is extremely important.
  2. Ensure all collateral schedules and legal agreements are easily accessible as these will impose constraints on decision-making.
  3. Take a centralized view of different types of obligations and requirements to enable good decision-making.
  4. Establish targeted analytics and Key Performance Indicators (KPIs) to measure and monitor progress of these initiatives.

These are vital foundational steps towards achieving an optimized collateral management environment.

Connected data: The key to better decision-making

Of course, bringing the data together is just one part of the process – the next step is to connect the data so that algorithms and analytics can be applied to it. Firms understand that the information is there for them to make better decisions, but they face a challenge in getting useable information and putting it to work.

The main obstacle, in most cases, is that they have built their operational structures and technology around specific areas of the business. To achieve a view across the whole enterprise, these businesses require coordination and connectivity across a large number of different internal and external systems – not easy to accomplish.

The solution lies in implementing a system that is easy to integrate and is targeted at connecting and harmonizing this data.

Avoiding costly re-engineering

There are sometimes negative connotations around the phrase ‘legacy technology’ but this is not always accurate. A firm’s existing securities lending or repo or margin systems may be good, but they will more often than not have been built as separate systems. Rather than re-engineering all these systems, what the firm needs is a layer that pulls these disparate systems together to ensure they are seeing a holistic and harmonized view of inventory, positions and obligations.

Most firms have taken some steps to improve their inventory management, but there is a wide difference across the industry in terms of the strategies adopted to achieve this objective. Some organizations are trying to address the issue in a tactical way, fixing one system at a time to see whether this gives them greater visibility, but this approach does not have much longevity from a strategic perspective.

The larger organizations have usually taken a more strategic approach. Some see it as primarily an internal engineering effort, while others are talking to firms such as Transcend as they seek to harness real-time data, collateral and liquidity.

Regardless of the approach taken, being able to optimize collateral and liquidity decisions at an enterprise level has huge benefits. The sheer number of firms and analysts that have explored the scale of these benefits underlines the significance of the opportunity, and we find that most firms are actively taking steps towards achieving these capabilities.

Optimization models can be implemented with a rules-based approach or even using more sophisticated algorithms (i.e. linear and non-linear programming models). These all have a vital role to play in monetizing the connected data across the firm.

Scaling the benefits

Being able to optimize collateral across business lines is an obvious benefit, but there are also advantages to be gained from reducing internal errors and fail rates. In addition, funding costs will fall because firms will be managing their funding operations more efficiently: improving securitized funding leads to a reduction in more expensive, unsecured funding.

Whether or not firms embrace centralization across all aspects of their business, it is clear that rationalizing complex systems and harnessing fragmented data sets provides for informed, confident and compliant decision-making. And once centralized funding and collateral management are fully achieved, the benefits of efficiency, cost-savings and liquidity attain even greater scale for the firm.

This article was originally published on Global Investor Group.

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In five years, 90% of funding will be done by machines

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You may disagree with the number of years or the percent, but everyone understands that automation in the funding and collateral space is occurring at a fast pace. The question is how you prepare for this inevitable future? Our view is that connecting data from disparate sources is the key to the next evolution in the funding markets. A guest post from Transcend. Read more

Collateral management: A path littered with obstacles

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As collateral rules have grown in complexity, so has the need for greater optimization – But as Tim Steele [of Funds Europe] discovers, achieving that can be painful.

Collateral has long been used as a tool for mitigating counterparty risk and obtaining credit, but now more than ever, it is the key determinant of an institution’s ability to engage in financial transactions in the cash or derivatives markets….

“If you optimize every pool or silo individually, as a firm you will by design not be optimized,” says Bimal Kadikar.

Read the full article from Funds Europe

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.

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