With an estimated $1.2 trillion of additional collateral needed to meet new margin requirements, urgent action is now unavoidable to tackle the ‘Great Collateral Squeeze’ head-on.
What we know is that the headline regulations – including DFA, EMIR, Basel III, and KYC – are exerting a powerful impact on capital market participants. The raft of regulatory activity also means that standards for reference data, collateral pooling, settlement activities, and broader risk mitigation are all changing. We also know that connectivity to industry utilities and market infrastructure is one potentially productive response to future collateral management challenges.
There can be no denying that $1.2 trillion is a potential black hole in the capital markets space. To avoid its powerful gravitational pull, we urgently need a Big Idea.
The Big Idea
We can transform the ‘collateral damage’ of a potential ongoing squeeze to our competitive advantage. However to do this demands deep knowledge. We need to start with a precise understanding of the impact of the legislation, leveraging this to set an informed strategic direction. We can then consistently implement operational best practice.
Given deep insights and a well-informed approach, collateral (whilst remaining very valuable) does not have to become scarce. The truly priceless asset is collateral management expertise. A single example illustrates this point; Capco estimates that if just one third of existing idle collateral could be mobilised, it would be sufficient to cover the expected additional margin requirements of $1.2 trillion.
Idle collateral is just one of many areas for improvement. More importantly, we need to avoid thinking in terms of isolated actions. A robust framework and joined-up action are what’s required. Institutions need strategically and operationally to ask some searching questions in key areas of their collateral management:
- Commercial Strategy Are we trading the right products, and in the right volumes, to make commercial sense in a new world of collateral requirements?
- Collateral Availability Are we able to meet our likely collateral requirements in a compliant manner?
- Key Change Drivers Do we have a clear picture of legislative impact and the key change drivers that will ensue?
- Collateral Concentrations Do we know where they are, how to access them and how to make ‘idle’ collateral work?
- Infrastructure Connectivity Do we fully understand its advantages and how best to access it?
- As-is operational state Is our current collateral management operational state fully fit for our needs today and scalable to meet the demands of tomorrow?
- Operational Improvements Do we know the improvements we need to make? Do we know how to make them? Do we have the internal expertise to specify and implement them?
The above list is clearly not exhaustive. Its salience will vary from one institution to another. But candid answers will reveal a great deal about institutional readiness to successfully meet the collateral management challenge. Going forward, collateral reserves alone will be insufficient in the face of the challenge. Collateral management expertise will make the difference between playing compliance catch-up and real competitive advantage.