Collateral Management Technology Is Boosting Efficiency and Adding Strategic Value

As financial transactions grow more sophisticated and complex, managing collateral extends beyond a regulatory exercise to one that brings strategic value – ensuring optimal asset pledges and accuracy in the trading portfolio. Technology has reinvigorated the collateral space, and sophisticated matching and reporting features make managing and optimizing collateral more seamless than ever before.

The use of collateral as a form of security pledged by a borrower to a lender to mitigate the lender's credit risk has been around for ages. Looking back as far as 2008, there was a large volume of bilateral over-the-counter (OTC) derivatives, but there wasn’t an equal amount of clearing. There was significant credit and regulatory risk in the process, with collateral exchange playing a minor role.

Steven Castleton

The Dodd-Frank Act changed all that, and collateral has since become integral to the trade lifecycle management process. Companies have had to up their game in collateral due to all of those changes. Today, leading organizations are being more thoughtful and strategic when using various forms of collateral, such as cash, securities, or other valuable assets eligible as collateral.

The Case for Large Institutions

Many large financial institutions and insurers are exchanging millions of dollars a day. With that volume comes significant risk. Organizations want to ensure there are no errors. There are several high-profile news cases where companies have sent money to other companies erroneously.

To reduce risk, the collateral process must be very well controlled. In the past, people viewed the collateral process as an administrative job and a cost center, which certainly is the case. Today, however, with new technology and the ability to post securities and additional items as collateral, there is high scrutiny on the process.

Siddharth Basu

Organizations are also focused on the collateral process because now with a platform and sophisticated software, you can use not only different types of securities to post as collateral, but also optimize them. This enables you to reduce administrative costs and, potentially, increase return — and any dollar saved is a dollar that gets sent to shareholders.

Technology, Flexibility and Accuracy

Today’s collateral management technology is highly flexible and can apply to many different types of contracts, both OTC and clearing. It can calculate margins quickly and efficiently. It may also include messaging functionality that automates communication and avoids the need to communicate via email.

In addition, avoiding manual calculation of the process significantly improves its accuracy. We have found that a best-of-breed collateral tool can unlock incredible success in this realm by streamlining three key elements of the process:

• Centralize: The collateral platform should be able to bring all data into one centralized space. This includes economic terms on trades, daily trade valuations, Credit Support Annex (CSA) agreements, listing of eligible collateral, securities to be pledged and their daily values. Flexible technology should also be able to embed both OTC and cleared trades. The platform should enable data consumption from multiple sources to allow complex margin calculations quickly. A centralized system helps to automate and condense efforts on these exercises, which leads to fewer errors and significant time savings.
• Integrate: One of the key benefits of a collateral platform is that it can integrate with dealer counterparties and obtain their pricing daily. This enables you to log into the platform and visually identify any mismatches or discrepancies. For bonds posted as collateral, calculating interest expense and keeping track of payment dates can also pose challenges. For many companies, this means using spreadsheets or other manual ways of managing the process. Integrating collateral calculations and payments within the platform also significantly reduces the operational burden, alleviating complex reconciliation involving numerous parties, dense legal agreements, and web of regulatory data and controls.
• Automate: A critical component of any technology is that it should elevate the process by improving efficiency and accuracy and reducing risks and errors. Minor errors in the process can cost millions due to the large notional values or volume of transactions. Often, we see clients manually create a prioritization matrix that identifies the pecking order of various forms of collateral to be allocated while also managing the numerous obligations stipulated with various counterparties through their CSA agreements. Automating tasks that adhere to a sequence of rules and established criteria can bring greater confidence into the process and allow managers to focus their attention on other, greater value-add exercises. This also helps optimize and reduce administrative costs.

Conclusion

Collateral management technology helps insurers, asset managers and financial institutions manage collateral more effectively in a centralized view and provide enhanced automation to reduce operational risk. This end-to-end workflow promises quicker onboarding, faster turnarounds and technical precision.

In a post-trade world, it is important now more than ever to remove manual processes and enhance the end-to-end workflow. The collateral management tool is an important function for financial institutions by creating optimization and automation across daily reconciliation.

Using this technology, financial institutions can reduce costs, improve operational efficiency and mitigate risk, making it an important focus area for many institutions in the financial industry.

Steven Castleton is managing director of Chatham Financial and runs the firm’s Financial Services sector. During his 15 years at Chatham, he has developed economic and accounting hedging strategies for banks, insurers and GSEs. He also develops strategic solutions for clients that refine and improve their derivative front-, middle- and back-office business processes. He is a CPA and received his Bachelor’s and Master of Accountancy degrees from Brigham Young University.

Siddharth Basu is a director in Chatham’s Financial Services sector advising clients on establishing hedging programs, assessing strategic and operational treasury design, integrating treasury functions post-acquisition, and presenting risk management strategies to executives and board of directors. He is a CPA and Chartered Financial Analyst (CFA) and is currently pursuing his MBA at The Wharton School of the University of Pennsylvania.