If you鈥檙e not moving forwards, you鈥檙e falling back
11 October 2022
Margin Reform CEO Shaun Murray reviews the key priorities for collateral and margin management today
Image: stock.adobe.com/Quality Stock Arts
As the Uncleared Margin Rules (UMR) phase-in comes to a gradual conclusion and firms tie up loose ends on documentation and shift from project oversight to business as usual, what is next for collateral and margin management across the industry? There is no argument that all firms trading derivatives have had their operating environments impacted by the changes in collateral management driven by regulation.
At Margin Reform, we think the market is at an inflexion point. At this juncture, we expect individual firms to choose different paths regarding collateral and margin management and how they approach the pre- and post-trade environments in which they operate.
Strategic alignment
Firms will look at this from the perspective of their own business and current operating model, which will be determined by the organisation鈥檚 size, complexity and efficiency. Looking at your internal environment in isolation is never a recipe that leads to a successful and smooth strategy in the long term. It is necessary to review external factors such as market best practice and industry learnings to determine whether you should invest in new technology, design new or adapt existing processes, and potentially invest in the people who can bring about the required operational changes. Margin Reform considers the following areas to be key priorities:
1. The competitive advantage of knowledge
People are a firm鈥檚 most important asset and the need for increased resources will continue to intensify. Approaches to collateral management will need to adapt from a reactive, fragmented, siloed function to one of strategic enablers with in-house expertise to manage the complexities of the evolving landscape. New hires should be offered the opportunity to enhance and consolidate their collateral understanding. The collateral strategy should ensure that everyone 鈥� from graduates and technologists to the board 鈥� upskill and develop a fundamental understanding of collateral and margin to make critical strategic gains.
2. Data management
Data continues to be front and centre of markets. Everyone is interested. Incomplete or inaccurate data affects trading, risk and operations. Future-proofing legal data as a digitised golden source (smart contracts) has never been more critical. Tokenisation and digitisation generally enable first movers to consider more sophisticated and efficient collateral management. This will increase collateral velocity (rehypothecation), enhance optimisation routines and liquidity management through greater visibility of assets, and reduce friction on settlements and drag on profit and loss (P&L).
3. Impact of Asian regulation
In August, China passed the law for the close-out netting of OTC derivatives, which will mean significant change for the derivatives market following a seismic effort by lawmakers, the International Swaps and Derivatives Association (ISDA) and market practitioners. As the dust settles, firms will be working through many challenges, such as the impact on legal documentation, derivatives pricing, capital and balance sheet management. Understanding external factors such as regulatory complexity and custodian agents will significantly impact collateral, margin and settlements. UMR regulation has recently been published by the Reserve Bank of India (RBI), adding complexity to the legal documentation requirements for onshore margining.
Change before you have to
Innovation, knowledge, strategy and 鈥渕oving forwards鈥� always comes at a cost. The decision-making process can be challenging against competing priorities within financial markets. Current volatile markets, global inflation and an increasing interest rate environment make collateral and margin management essential levers for firms to manage costs, liquidity and the balance sheet.
At Margin Reform, we think the market is at an inflexion point. At this juncture, we expect individual firms to choose different paths regarding collateral and margin management and how they approach the pre- and post-trade environments in which they operate.
Strategic alignment
Firms will look at this from the perspective of their own business and current operating model, which will be determined by the organisation鈥檚 size, complexity and efficiency. Looking at your internal environment in isolation is never a recipe that leads to a successful and smooth strategy in the long term. It is necessary to review external factors such as market best practice and industry learnings to determine whether you should invest in new technology, design new or adapt existing processes, and potentially invest in the people who can bring about the required operational changes. Margin Reform considers the following areas to be key priorities:
1. The competitive advantage of knowledge
People are a firm鈥檚 most important asset and the need for increased resources will continue to intensify. Approaches to collateral management will need to adapt from a reactive, fragmented, siloed function to one of strategic enablers with in-house expertise to manage the complexities of the evolving landscape. New hires should be offered the opportunity to enhance and consolidate their collateral understanding. The collateral strategy should ensure that everyone 鈥� from graduates and technologists to the board 鈥� upskill and develop a fundamental understanding of collateral and margin to make critical strategic gains.
2. Data management
Data continues to be front and centre of markets. Everyone is interested. Incomplete or inaccurate data affects trading, risk and operations. Future-proofing legal data as a digitised golden source (smart contracts) has never been more critical. Tokenisation and digitisation generally enable first movers to consider more sophisticated and efficient collateral management. This will increase collateral velocity (rehypothecation), enhance optimisation routines and liquidity management through greater visibility of assets, and reduce friction on settlements and drag on profit and loss (P&L).
3. Impact of Asian regulation
In August, China passed the law for the close-out netting of OTC derivatives, which will mean significant change for the derivatives market following a seismic effort by lawmakers, the International Swaps and Derivatives Association (ISDA) and market practitioners. As the dust settles, firms will be working through many challenges, such as the impact on legal documentation, derivatives pricing, capital and balance sheet management. Understanding external factors such as regulatory complexity and custodian agents will significantly impact collateral, margin and settlements. UMR regulation has recently been published by the Reserve Bank of India (RBI), adding complexity to the legal documentation requirements for onshore margining.
Change before you have to
Innovation, knowledge, strategy and 鈥渕oving forwards鈥� always comes at a cost. The decision-making process can be challenging against competing priorities within financial markets. Current volatile markets, global inflation and an increasing interest rate environment make collateral and margin management essential levers for firms to manage costs, liquidity and the balance sheet.
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