By: Lee Burchell
The counterparties to cleared OTC trades must post high-grade collateral to ensure settlement finality. The $141 trillion in gross notional outstanding OTC trades, characterized as too high risk for CCPs (therefore ineligible for clearing), will still trade bilaterally but with new conditions attached.
To fortify the rules for bilateral OTC trading, the International Organization of Securities Commissions (IOSCO) and the Basel Committee on Banking Supervision (BCBS) introduced margining requirements within a global policy framework. Already introduced in the U.S., Canada, and Japan on September 1, 2016, these rules will be phased in for other jurisdictions including Australia, the European Union (EU), Hong Kong, India, Singapore and Switzerland, from starting March 1, 2017.
The new legislation has many wondering where firms can obtain collateral, which is now a valuable asset due to its limited supply.
Other post-crisis requirements, including Basel III and Solvency II, force systemically important financial institutions (SIFIs) to hold risk-weighted capital and high-quality liquid assets (HQLAs) in order to preserve balance sheet strength. This consumes a lot of the collateral supply.
Traditional sources of collateral are in retreat. Regulatory constraints on re-hypothecation and concentration limits on where collateral is sourced restrict the pool of eligible collateral and exacerbate illiquidity in the collateral markets. These constrictions mean small- to mid-sized fund managers are at risk of being excluded from the collateral market. Basel III makes the regulatory cost of repo desks so high that banks will provide repo desk services only to larger, more strategic clients.
Experts predict a 150% increase in demand for collateral in the run-up to the March deadline for posting variation margin on non-centrally cleared OTCs.
Since it’s now harder to find eligible collateral, managers must have a sound collateral management system and renegotiate credit support annexes (CSAs) to account for the new margining rules under the BCBS-IOSCO provisions. The variation margin (VM) protocol by ISDA helps managers seamlessly update their existing CSAs to incorporate the changed margining requirements.
To effectively meet margin calls, firms must have suitable technology and operations and a holistic view of how they manage their collateral. Delegating collateral management to a third party with in-depth understanding of the market and resources is efficient and cost-effective. SS&C recently published a whitepaper “Intelligent collateral management: An operational necessity for fund managers”, which further examines what the buy-side needs to do to prepare for these changes.
Since February 2016, GoMargin the straight-through-margining collateral management service from SS&C - has been helping clients with all their collateral management needs. For more information, please contact firstname.lastname@example.org.