By Brendan Bradley, Chairman at Tokenovate.
The recent ISDA/Investment Association Collateral Management Evolution conference, held in London on June 12, brought to light critical issues and emerging trends in the ever-evolving collateral management landscape. As market volatility increases, collateral liquidity diminishes, posing significant challenges. In this blog, we’ll delve into the key themes discussed at the conference, including the impact of regulatory requirements, the role of technology and tokenisation, and the innovative solutions offered by firms such as Tokenovate.
Volatility and Collateral Liquidity: Drivers and Responses
Market volatility often leads to reduced collateral liquidity, driven by heightened margin calls, market participants hoarding liquidity, and increased haircuts on less liquid assets. Firms are responding by enhancing stress-testing methodologies to anticipate collateral demands better. This involves advanced scenario analysis and frequent stress tests to understand the impact of extreme market conditions.
To manage collateral across multiple products, firms are adopting a holistic approach, integrating collateral data, and utilising sophisticated optimisation tools. Therefore, there is more requirement for technology providers that offer solutions enabling seamless integration and real-time visibility into collateral positions, aiding firms to reach efficient collateral management.
Pre-emptive Planning for Defaults
Planning for the porting of positions with a clearing member following a default is crucial. Firms are developing robust contingency plans, identifying potential clearing members in advance, and establishing the necessary legal and operational frameworks. Blockchain-powered smart contracts could provide an automated and transparent mechanism to manage post-trade lifecycle events, ensuring a smooth transition during defaults.
Optimising Collateral Requirements and Managing Exposure
Netting opinions have become vital in optimising collateral requirements, with new clearing brokers and central counterparties (CCPs) constantly reviewed to mitigate counterparty credit risk. However, challenges in mapping data models from different CCPs and ensuring correct collateral eligibility persist. The increasing use of platforms like Swap Agent, driven by the need to pledge initial but not variation margin, highlights the shift towards a more holistic approach in collateral management.
Firms are also focusing on legal documentation, ensuring netting agreements align with Credit Support Annex (CSA) agreements. Technology platforms are facilitating this process for swap agreements, streamlining legal documentation and operational processes.
Addressing Data Harmonisation and Expanding Collateral Pools
Despite collaboration among custodians, a lack of data harmonisation remains a concern. Buy-side firms are expanding the number of counterparties and eligible collateral, seeking synergies and operational efficiency. The use of government bonds, including those with higher haircuts, and the prevalence of cash-only CSAs are notable trends. Firms are also investing in stress-testing their collateral, including eligibility and haircuts, as part of comprehensive forecasting.
Enhancing Collateral Mobility and Tokenisation
The demand for high-quality liquid assets (HQLAs) is increasing due to regulatory requirements. Therefore, firms are expanding their collateral pools to include ETFs and Money Market funds with appropriate haircuts. Tokenisation, which can be facilitated by Tokenovate, plays a crucial role in enhancing collateral mobility. By creating digital twins of real-world assets, tokenisation improves tradability, accessibility, fractionalisation, and liquidity.
The UK’s Gilt crisis underscored the importance of collateral mobility, with tokenisation emerging as a viable solution. Tokenovate’s use of UTXO protocols and blockchain-powered smart contracts ensures compliance with regulatory standards, enabling efficient management of digital assets.
Industry Trends and Operational Efficiency
Several industry trends are reshaping collateral management operations. Firms are focusing on reducing resource requirements while minimising operational, counterparty, and liquidity risks. Streamlining processes across onboarding, documentation, margin call calculations, settlements, and dispute reconciliation is essential.
The use of the Common Domain Model (CDM) drives standardisation and interoperability, allowing different systems and firms to work together seamlessly. By leveraging AI and automation, vendors can help firms optimise operations, reducing manual intervention and associated risks.
Regulatory Impacts on Collateral Management
While the implementation of clearing mandates and margining requirements for non-cleared derivatives may seem like old news, new regulatory initiatives are on the horizon. Policymakers continue to introduce measures that will impact liquidity management and collateral operations. In particular, a proposed overhaul to capital rules as part of stricter Basel III capital adequacy requirements will increase pressure on banks available collateral. Staying ahead of these changes is crucial for firms to ensure compliance and operational efficiency.
Embracing Technology for Future-Ready Operations
Technology is pivotal in adapting to increased margin call and settlement volumes. The industry is moving towards greater automation and integration to streamline operations. Tokenovate’s solutions, including tokenisation and blockchain-powered smart contracts, enable firms to manage their post-trade workflows more effectively. Their infrastructure supports collateral mobility, utilising UTXO protocols to create and maintain digital records managed by smart contracts. This can enhance the utility of assets in both trading and collateral.
Conclusion
The collateral management landscape is rapidly evolving, driven by market volatility, regulatory demands, and technological advancements. Firms are adopting innovative approaches to manage collateral efficiently and prepare for future challenges. Tokenovate can provide the tools and infrastructure needed to navigate this complex environment. By leveraging tokenisation and smart contracts, Tokenovate is helping firms enhance collateral mobility, optimise operations, and reduce risks, paving the way for a more resilient and efficient financial system.
