The Road to an Effective Collateral Management Program

4 Markets and Securities Services  2 Organize: Align Firm Structure and Resources As firms select their optimal collateral management model, is important to ensure the right organizational alignment. Since collateral management was once a true back and middle office operational function, participants may find that the right talent and resources to execute their preferred strategy are not yet completely aligned. To ensure maximum efficiency throughout this process, firms should address three key issues. • Dedicate a Team Appoint a head of collateral management with a dedicated team that has a centralized, enterprise-wide view and can deploy a strategy to optimize available collateral, funding and liquidity. This person should be empowered to reach across business lines and request necessary resources. • Review Legal Bandwidth Regulators recommend firms begin preparation 24 months in advance of the implementation date of the new phased-in margin rules. This is very likely to put a squeeze on legal teams within the firm as they work to negotiate the multitude of new documentation. • Remove Silos The greatest efficiencies can only be realized through a holistic, firm-wide picture of globally available assets and obligations. Management should work toward seamless integration across Risk, Operations, Technology, Legal and Compliance, as well as across disparate geographies, given the cross-border implications of new regulatory regimes.  3 Optimize: Find the Right Collateral Collateral management practices impact front-office activities. The choice of collateral can negatively affect investment performance, creating collateral drag. To understand which collateral to select, an institution’s full inventory across borders and among repositories needs to be considered. A single, enterprise-wide collateral pool will help guide decision making and can mitigate risk by preserving assets that could provide essential liquidity during stressed periods. Identifying and deploying assets that may be otherwise hidden in silos will help minimize costs related to accessing and securing collateral. Further, posted collateral should be evaluated for both its funding and opportunity cost as “cheapest to deliver” can have multiple interpretations. The opportunity cost will be the lost benefit received if the collateralized asset was deployed for a different purpose. While it is difficult to quantify the drag that collateral lock-up has on overall returns, firms should consistently evaluate the impact of posting cash versus other instruments and ensure that they are regularly calibrating their cash reserves. It may be tempting to post cash as collateral if no other eligible asset is available; however, large cash buffers drag performance. Some jurisdictions have constraints for posting cash collateral. Cash may also be best preserved for other purposes, such as investor redemptions or new investment strategies. High-quality liquid assets are in demand following regulatory changes and firms are likely to find optimal solutions by assessing collateral options based on their liquidity and grade. Variation Margin (VM) changes daily as it covers mark-to- market movements, and thus cash has been used as the primary source as it is easy to settle. Cash collateral may also be a requirement for VM in certain circumstances. An integrated collateral management program can also identify opportunities to raise liquidity or enhance returns from transformations, such as: • Internalization Some market participants do not have to look far to source new collateral or liquidity. Firms with larger corporate structures or asset managers with subaccounts at lower levels can trade collateralized assets without having to engage external counterparties. If risk is properly managed, firms can use their long inventory and client re-hypothecated securities to efficiently cover their collateral needs.