The Road to an Effective Collateral Management Program

2 Markets and Securities Services Collateral management is becoming a strategic initiative for investment firms. Once exclusively a risk management and regulatory compliance effort, it is now also viewed as an opportunity to manage liquidity, avoid collateral drag, and realize returns from collateral transformations. Various collateral regulations have come into play over the past ten years, encouraging firms to take a programmatic and strategic approach to collateral management. The Global Financial Crisis had a long lasting impact on how collateral is managed and ways in which collateral strategies can be implemented. Inadequate capital influenced the collapse of a number of institutions and the globally coordinated regulatory response highlighted the lack of risk management structures at the time. G20 nations’ commitment to devise an international regulatory framework for the over-the-counter derivatives markets and market participants continues with today’s ongoing effort to craft regulation that minimizes counterparty credit risk and widespread contagion risk. Collateral programs continue to face regulatory pressure following the 2016 introduction of uncleared margin rules, which require firms to post initial margin (IM) for certain uncleared derivatives. So far, a relatively small number of firms have been affected by these requirements because of the high Average Aggregate Notional Amount (AANA) threshold — a regulatory definition of material swap exposure between counterparties. However, in 2020 the AANA threshold for IM drops dramatically from $750 billion to $50 billion and drops again to $8 billion in 2021. According to the International Swaps and Derivatives Association, at least 1,000 entities and over 9,000 trading relationships will be affected by the final phases of the IM rules. 1 Many asset managers will find themselves among those included in the final phases, and firms should start planning now. Failure to prepare by the deadline means that in-scope entities will not be able to trade non-centrally cleared derivatives. This could limit a firm’s access to the derivatives market and its ability to hedge risk while also potentially impacting liquidity. Uncleared Margin Rules — Participant Size by Phase Average Annual Notional Amount 1 Sept ‘19 1 Sept ‘17 1 Sept ‘18 1 Sept ‘20 1 Sept ‘21 1 Sept ‘16 Phase-in Date Each firm annually calculates its AANA. A pair of market participants are subject to the rules in September of the year when both parties/groups cross the relevant threshold. As the AANA drops, more firms will come in scope of UMR. Wave 1 > $3,000 B Wave 2 > Wave 2 > $2,250 B Wave 3 > $1,500 B Wave 4 > $750 B Wave 5 > $50 B Wave 6 > $8 B 1 Source: International Swaps and Derivatives Association, Margin Survey Full Year 2017