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Managing Collateral:
Optimal allocation at the
heart of the business
Top Ten Challenges for
Investment Banks 2015
02
Manag...
02
Managing Collateral: Optimal
allocation at the heart of the business
Regulatory changes and market developments have fo...
3
In addition, market developments and
competition have played their role. Banks
have tended to favour more collateralised...
4
of at least 4 billion Euros across the
industry as a whole.
Reaching a mature state requires the
effective addressing of...
5
Optimal collateral allocation at
all times
The need to centralise collateral
management and secured funding
activities i...
About Accenture
Accenture is a global management
consulting, technology services and
outsourcing company, with more
than 3...
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Top Ten Challenges for Investment Banks 2015: Regulation: Challenge 2

Read a report from Accenture Capital Markets on managing collateral and optimal allocation at the heart of the business.

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Top Ten Challenges for Investment Banks 2015: Regulation: Challenge 2

  1. 1. Managing Collateral: Optimal allocation at the heart of the business Top Ten Challenges for Investment Banks 2015 02 ManagingCollateral: Optimalallocationatthe heartofthebusiness
  2. 2. 02 Managing Collateral: Optimal allocation at the heart of the business Regulatory changes and market developments have focused banks’ attention on effective collateral management, both for their own businesses and as a service to their clients. As traditional operating models are challenged by low margins and significant regulatory change, the optimisation of collateral assets is part of a wider focus on resource allocation across the whole investment banking industry. Most investment banks have already recognised the importance of achieving a single, consolidated view of collateral across the full trade lifecycle and all asset classes, and many have taken steps to implement such a view. However, Accenture’s belief is that this is only the basic starting point on the journey towards truly effective collateral optimisation. The key challenge is how to maximise the business benefit of effective collateral deployment at all times: through accurately and quickly measuring collateral requirements on an intra-day basis and rapidly redistributing collateral around the business to where it is needed most. Collateral management is already centre stage Recognition of the importance of collateral has been driven by regulatory mandate and market developments. A raft of provision has been mandated – across cleared and non-cleared markets –by regulations including Dodd-Frank, EMIR, Basel III / CRD IV and BSCO/IOSCO. Standardised derivatives contracts must now be traded on exchanges or electronic trading platforms and cleared through Central Counterparties (CCPs) while bilateral contracts are now subject to higher capital requirements and rules concerning the daily exchange of different margin types. 2 61% The share of cleared trades has risen consistently over the last five years, reaching 61% at the end of 2013
  3. 3. 3 In addition, market developments and competition have played their role. Banks have tended to favour more collateralised secured lending since the financial crisis, reflective of a reduced risk appetite. Market participants have also pushed to move trades to CCPs and/or document them with Collateral Agreements (CSAs) in order to reduce capital requirements for their lines of business. The share of cleared trades has risen consistently over the last five years, reaching 61% at the end of 2013 (see Fig.1) In addition, by the end of 2013, 91% of OTC derivative trades used a CSA, up from 73.7% in 2012 (see Fig.2). Most collateral is still in the form of cash, with an associated higher cost of funding. However there is an increasing movement towards the use of other forms of collateral, predominantly government and high-grade corporate securities, while equities are also increasingly acceptable as collateral at CCPs. Collateral as a business line Against this backdrop, the role of the collateral function within banks’ business and operating models has fundamentally changed: it is no longer a support function at the end of the trade lifecycle, but now sits at the core of the business. This change must be reflected in a new operating model. Collateral management needs to be viewed not as a cost centre but rather as a provider of an invaluable service to the trading function and to clients alike. Once this model matures, banks will start to see the benefits of effective collateral management not only in reducing funding costs, but as a revenue-generating function. Indeed, Accenture believes that a movement from “Foundation” to “Comprehensive” maturity level for collateral management (see Fig.3) has the potential to unlock collateral inefficiencies Figure 1: OTC IR derivative trades cleared vs. non-cleared 2007 2008 2009 2010 2011 2012 2013 400 350 300 250 200 150 100 50 0 70% 60% 50% 40% 30% 20% 10% 0% Source: ISDA, Accenture Research • Cleared (adj. for double-counting) • Non-cleared • Share of cleared (right scale) Source: Collateral Management, Unlocking the Potential in Collateral. Accenture Research and Clearstream
  4. 4. 4 of at least 4 billion Euros across the industry as a whole. Reaching a mature state requires the effective addressing of several key factors: • Liquidity and capital management: Collateral burdens for OTC derivatives are currently so significant that they are impacting liquidity profiles and the cost of funding across the whole bank, and must be factored into capital and liquidity planning • Efficient use of assets: It is absolutely critical to improve the cost of funding through ensuring that all available inventory is used in the most effective way possible • Risk management: Reducing operational and settlement risk with the improvement of robust collateral management processes and systems as part of a trustworthy network of partners for settlement and custody will be important • Client service offering: Where possible, identifying and marketing new services that can be offered to clients directly or as part of existing services. It is absolutely critical to improve the cost of funding through ensuring that all available inventory is used in the most effective way possible Figure 3: Collateral Management Maturity Model Source: Accenture Research Real-time view of collateral movements, allocation decisions and simulation / visualisation techniques RelativeValue Enterprise-wide inventory and consideration of collateral in trade pricing and funding decisions Consolidation of certain processes across asset classes and basic optimisation Asset Inventory and agreements across individual asset classes only, no consolidated enterprise wide view. Some consolidation of assets and agreements across asset classes, for example OTC and Listed Derrivatives, SBL and Repo desks. Full visibility of common asset inventory across across the firm and optimum representation visibility of agreements data in systems. Enhanced view of collateral movement and settlement to provide up to date view of positions across organisation at any given time. Lack of collateral optimisation: assets and obligations matched on a first-come, first-served basis. Basic optimisation in the form of Cheapest-to-Deliver collateral allocation. Basic partner network management functions. Full tracking of encumbered/ unencumbered collateral, optimisation algorithms based on cost models and allocation methods. Real time cost/benefit analysis in response to market events, with collaborative algorithms to support continued optimality of allocation. Collateral management is managed as an end-of-day process within the back office - little or no interaction with Front Office. Post factum communication and reporting is available to Front Office regarding the financing activity. Full appreciation and consideration of collateral in trade pricing and decision making by Front Office including OIS discounting. Collateral is traded as any other asset class, both serving to optimise the required collateral from other business lines as well as a profit centre in its own right. Valuations performed differently by individual desks within the bank. Valuation process is standardised and best practices are shared across the different desks. Accurate pricing of collateral assets and legal agreements. Optimum pricing models to perform what-if analysis for future requirements and liquidity management. Real time simulation and visualisation techniques to spot opportunities for improved allocation. Different allocation strategies deployed valuing collateral accordingly. Asset Agreement Inventory Collateral Tracking Optimisation Front Office Collaboration Robust Valuation Optimal “At all times” Comprehensive Managed Foundation Complexity Foundation Managed Comprehensive Optimal Collateral Management is basic, back-office processing task handled separately by individual lines of business Figure 2: Percentage of trades subject to collateral agreements end- 2011 end- 2012 end- 2013 71.4% 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% Source: ISDA margin surveys 91.0% 73.7%
  5. 5. 5 Optimal collateral allocation at all times The need to centralise collateral management and secured funding activities in the group has been identified, with many banks striving to implement a consolidated view of collateral requirements and resources across business units, geographies and products. We view this as a necessary, fundamental starting point to leverage future benefits, and advise banks not addressing this challenge to aggressively pursue change. The focus for industry-leading banks should be to ensure that collateral deployment dynamically identifies and matches the needs of the business at all times. There are two key factors that are essential for this – mobility and velocity. Moving to a mature state will require enormous rework in the following areas: Operating Strategy: Banks must assess if they are capable of delivering an integrated collateral management and optimisation service in-house, or if they are better served by outsourcing to a provider or undertaking a joint venture with a third party. Banks will also need to group counterparties and define different collateral strategies for each of those groups (e.g. best collateral first for market infrastructures, cheapest-to-deliver for peer banks). Functional Design: The scope and number of functions performed by a collateral function will be vastly expanded from its current state. Banks need to ensure that the requisite blend of skills, resources and strategic positioning is available to undertake this challenge. Capabilities and Processes: The modern collateral function will be required to analyse and measure the collateral demands of an entire organisation on an intra-day basis. Current processes and capabilities will need to be overhauled and upgraded to meet the concurrent challenges of ensuring sufficient collateral is always available to support the business, reducing cost of funding, optimising collateral through allocating the cheapest assets from the available inventory, and pursuing rehypothecation where possible. Technology: Crucial to supporting the collateral function in the future is the targeted, effective use of technology. Banks are already developing algorithms to assess collateral needs rapidly and accurately. These new models must be seamlessly integrated with existing capabilities that manage inventory, collateral requirements and margin calls, valuation of securities and communication with counterparties. Banks have made significant progress in consolidating their collateral operations, but significant additional work is required to truly optimise the collateral function and make it a core driver of the future banking business model. Mobility • Collateral must have the ability to be redistributed quickly across the business where it is needed most. • Internal capabilities (analytics, algorithms etc.) dynamically align collateral allocation with market conditions and business stategy • Banks use all their available positions as security, quickly analysing if they are accessible • Impediments, such as market settlement or constraints minimised. Velocity • Collateral requirements assessed in the real-time using: - precise and rapid measurement of business need, - valuation and suitability assessment of existing stock - an understanding of the cost of funding - a particular focus on maximising re-hypothecation opportunities. • This must be conducted on an intra-day basis. Optimal Collateral Allocation Banks have made significant progress in consolidating their collateral operations but significant additional work is required to truly optimise the collateral function
  6. 6. About Accenture Accenture is a global management consulting, technology services and outsourcing company, with more than 305,000 people serving clients in more than 120 countries. Combining unparalleled experience, comprehensive capabilities across all industries and business functions, and extensive research on the world’s most successful companies, Accenture collaborates with clients to help them become high-performance businesses and governments. The company generated net revenues of US$30.0 billion for the fiscal year ended Aug. 31, 2014. Its home page is www.accenture.com. Accenture Experts To discuss any of the ideas presented in this paper please contact: José Villar Managing Director, Capital Markets, Madrid jose.m.villar@accenture.com +34 91 546 9229 Bart Coppens Capital Markets, Brussels b.coppens@accenture.com +32 22 267 325 James Hopkins Capital Markets, London james.c.hopkins@accenture.com +44 20 3335 0936 Disclaimer This report has been prepared by and is distributed by Accenture. This document is for information purposes. No part of this document may be reproduced in any manner without the written permission of Accenture. While we take precautions to ensure that the source and the information we base our judgments on is reliable, we do not represent that this information is accurate or complete and it should not be relied upon as such. It is provided with the understanding that Accenture is not acting in a fiduciary capacity. Opinions expressed herein are subject to change without notice. Copyright © 2014 Accenture All rights reserved. Accenture, its logo, and High Performance Delivered are trademarks of Accenture.

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