Market dynamics force firms to seek out new sources of collateral
In confronting market headwinds, financial institutions are finding themselves under pressure to manage their collateral as efficiently as possible, prompting more firms to engage with providers of third-party collateral management solutions, explains Nerin Demir, head of repo and collateral management at SIX
Image: Nerin Demir
As central banks attempt to tame inflationary risk, many are resorting to substantial interest rate rises. These rate hikes are impacting financial institutions’ ability to finance trades and even post collateral. With the European Central Bank (ECB) poised to raise rates even further, it is expected that financial institutions will seek out alternative funding sources via the repo market.
Repo volumes in Europe have increased exponentially over the past few years. According to analysis by the International Capital Market Association (ICMA), the total value of repos and reverse repos outstanding on the books of the 61 institutions featured in the study stood at €10.3 trillion, a substantial jump from the previous record of €9.68 trillion, corresponding to a 12.8 per cent year-on-year growth.
It is not just major financial institutions which are leveraging the repo and securities finance markets, but so too are small and medium-sized market participants. It is here where problems can start to emerge.
This is because these institutions are often not as familiar with how securities finance operations and repo markets work, mainly because the barrier to entry has historically been very high. Such institutions are often reliant on manual processes, which can also create problems when accessing these markets.
Collateral demands intensify
Exacerbating matters, the demand for high-quality collateral has intensified for financial institutions. This follows the introduction of Phase 6 of the BCBS-IOSCO’s Uncleared Margin Rules (UMR) in September 2022. Phase 6 of the UMR subjects a wider scope of bilateral counterparties trading uncleared over-the-counter (OTC) derivatives to additional margining requirements — forcing them to source and post further collateral.
The provisions apply to any financial institution with an aggregate average notional amount (AANA) above the US$8 billion threshold, something which has mostly impacted asset managers and hedge funds.
Feeling the squeeze
As collateral pressures increase, financial institutions are also finding themselves dealing with challenging macro headwinds and rising operational costs. Market volatility — most recently illustrated by the banking crisis in the US and Europe — caught a number of firms off-guard, while rate rises and inflation are also hurting performance, particularly among investors.
These difficult performance conditions have resulted in investment firms suffering substantial outflows. For example, assets under management (AUM) at mutual funds and exchange traded funds (ETFs) in the US declined by almost 17 per cent between January 2022 and the end of October 2022.
Furthermore, financial institutions — ranging from global custodian banks and brokers to asset managers — are being squeezed on fees, which is adversely affecting their revenues. At the same time, operational costs are also trending upwards, sparked by the implementation of new regulations, particularly in the EU.
Amid these tough circumstances, the ability to manage collateral effectively has never been more important.
Identifying the right products
Currently, collateral is managed across the front and back offices through systems developed by a range of technology services providers. The complexity and lack of visibility brought on by this means human intervention is high, as constant monitoring and communication is needed across different business silos to avoid errors.
To improve these processes, firms are turning to high calibre providers such as SIX.
Financial institutions are looking to leverage collateral management solutions, including the SIX Collateral Cockpit and the Triparty Collateral Management (TCM) service. In the case of the Collateral Cockpit, the solution’s interface is designed to join up fragmented front and back-office information systems to give repo professionals the ability to view and manage collateral in real-time, on one platform. This solution aims to enable banks to enter a new market segment without major investment and effort.
Similarly, the TCM service allows the two parties to a transaction to delegate their day-to-day operational responsibilities around collateralisation to SIX.
SIX performs tasks such as the selection and automatic execution of collateral transfers and ongoing validation that exposures are being appropriately collateralised through daily mark-to-market checks on the collateral, throughout the lifecycle of the transaction.
Other solutions include CO:RE, which is aimed at collateral and repo trading. CO:RE, which is targeted at banks, broker-dealers, insurance firms, commercial banks and asset managers, brings together trading and collateral management capabilities in a fully integrated value chain.
CO:RE is a multi-faceted electronic trading facility providing single-point access to more than 160 counterparties trading repo contracts across 14 currencies. Central and commercial bank money are available, alongside access to the Swiss National Bank’s (SNB’s) primary market for the issuance of money-market instruments.
Moving forward, SIX is introducing a new Linked Repo segment, complementing its Repo Market solution, which will allow participants to either upgrade or downgrade their collateral via two repo trades with cash netting.
An intelligent approach
In today’s volatile market conditions, financial institutions need to identify ways to simplify their operational processes, maximise their collateral usage and reduce the operational risk. Adoption of cutting edge collateral management solutions is one way that they can go about it.
Repo volumes in Europe have increased exponentially over the past few years. According to analysis by the International Capital Market Association (ICMA), the total value of repos and reverse repos outstanding on the books of the 61 institutions featured in the study stood at €10.3 trillion, a substantial jump from the previous record of €9.68 trillion, corresponding to a 12.8 per cent year-on-year growth.
It is not just major financial institutions which are leveraging the repo and securities finance markets, but so too are small and medium-sized market participants. It is here where problems can start to emerge.
This is because these institutions are often not as familiar with how securities finance operations and repo markets work, mainly because the barrier to entry has historically been very high. Such institutions are often reliant on manual processes, which can also create problems when accessing these markets.
Collateral demands intensify
Exacerbating matters, the demand for high-quality collateral has intensified for financial institutions. This follows the introduction of Phase 6 of the BCBS-IOSCO’s Uncleared Margin Rules (UMR) in September 2022. Phase 6 of the UMR subjects a wider scope of bilateral counterparties trading uncleared over-the-counter (OTC) derivatives to additional margining requirements — forcing them to source and post further collateral.
The provisions apply to any financial institution with an aggregate average notional amount (AANA) above the US$8 billion threshold, something which has mostly impacted asset managers and hedge funds.
Feeling the squeeze
As collateral pressures increase, financial institutions are also finding themselves dealing with challenging macro headwinds and rising operational costs. Market volatility — most recently illustrated by the banking crisis in the US and Europe — caught a number of firms off-guard, while rate rises and inflation are also hurting performance, particularly among investors.
These difficult performance conditions have resulted in investment firms suffering substantial outflows. For example, assets under management (AUM) at mutual funds and exchange traded funds (ETFs) in the US declined by almost 17 per cent between January 2022 and the end of October 2022.
Furthermore, financial institutions — ranging from global custodian banks and brokers to asset managers — are being squeezed on fees, which is adversely affecting their revenues. At the same time, operational costs are also trending upwards, sparked by the implementation of new regulations, particularly in the EU.
Amid these tough circumstances, the ability to manage collateral effectively has never been more important.
Identifying the right products
Currently, collateral is managed across the front and back offices through systems developed by a range of technology services providers. The complexity and lack of visibility brought on by this means human intervention is high, as constant monitoring and communication is needed across different business silos to avoid errors.
To improve these processes, firms are turning to high calibre providers such as SIX.
Financial institutions are looking to leverage collateral management solutions, including the SIX Collateral Cockpit and the Triparty Collateral Management (TCM) service. In the case of the Collateral Cockpit, the solution’s interface is designed to join up fragmented front and back-office information systems to give repo professionals the ability to view and manage collateral in real-time, on one platform. This solution aims to enable banks to enter a new market segment without major investment and effort.
Similarly, the TCM service allows the two parties to a transaction to delegate their day-to-day operational responsibilities around collateralisation to SIX.
SIX performs tasks such as the selection and automatic execution of collateral transfers and ongoing validation that exposures are being appropriately collateralised through daily mark-to-market checks on the collateral, throughout the lifecycle of the transaction.
Other solutions include CO:RE, which is aimed at collateral and repo trading. CO:RE, which is targeted at banks, broker-dealers, insurance firms, commercial banks and asset managers, brings together trading and collateral management capabilities in a fully integrated value chain.
CO:RE is a multi-faceted electronic trading facility providing single-point access to more than 160 counterparties trading repo contracts across 14 currencies. Central and commercial bank money are available, alongside access to the Swiss National Bank’s (SNB’s) primary market for the issuance of money-market instruments.
Moving forward, SIX is introducing a new Linked Repo segment, complementing its Repo Market solution, which will allow participants to either upgrade or downgrade their collateral via two repo trades with cash netting.
An intelligent approach
In today’s volatile market conditions, financial institutions need to identify ways to simplify their operational processes, maximise their collateral usage and reduce the operational risk. Adoption of cutting edge collateral management solutions is one way that they can go about it.
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