Collateral Optimisation, is it a case of The Emperor’s New Clothes?

Everyone has heard the tale of the Emperor’s New Clothes… a fairy tale about an Emperor who pays a lot of money for something that can only be seen by ‘wise’ people.

The clothes do not really exist. Much like the need for many Buy-Side firms to pay a lot of money to optimise their collateral.

The term optimisation has been prevalent over the past few years. You can barely read an article about collateral management without being told that sky is going to fall down unless you optimise your collateral. You also have articles pushing the idea of the ‘collateral squeeze’ that is yet to materialise, and that adopting n-level optimisation algorithms is essential for almost all Buy-Side firms.

Although many consultancy firms privately admit optimisation is mostly smoke and mirrors, legacy collateral technology vendors still need to over complicate the issue to justify their huge cost base and extortionate prices; selling million pound technology solutions requires a climate of fear in the market, so that anyone not spending huge sums of money isn’t ‘wise’ enough to see The Emperor’s Clothes.

Buy-Side companies need to remember that vendors need to sell an issue to support their own agenda; they need to make the world seem as scary and over complicated as possible.

The truth is that the majority of the Buy-Side just wants visibility of a single, collated and consolidated collateral pool with the ability to make the best use of what they have; the focus is not on over-complicated optimisation yet. They need to be able to assess what they have in a small amount of time to make decisions that have a great impact on the business as a whole.

In fact, the Head of Treasury of a leading bank commented on what was important to them: I’ll give you the 3 C’s…. Clear, Un-Cluttered and Concise… We need to know what we have available day to day and more importantly in times of market stress”.

For most of the Buy-Side, and of course there are going to be exceptions, the challenge isn’t sophisticated optimisation of collateral, it is making efficient use of what they’ve got. As well as ‘The Top Three Challenges the Buy-Side are facing’ (LINK), getting visibility over what their firms are holding and being able to cope with increasing volumes of calls without having the operational headaches of volume sensitivity is the main priority.

Many Buy-Side institutions already have assets just sitting around waiting to be used. Asset managers will usually have pools of eligible assets available and corporates and insurers are often long cash, the challenge is to efficiently mobilise these assets. Due to the levels of interest rates at the moment and the cheap price of cash, many brokers are pushing their buy-side clients to renegotiate CSAs or at least commit to only margining in single currency cash, making optimisation impossible. Therefore, a collated and visualised view of collateral pools and where they can be used is much more beneficial than over priced optimisation algorithms.

Although expensive legacy systems need to sell the idea of optimisation, to justify their existence, we have spoken to a number of Buy-Side companies and they simply do not want to hear about optimisation when being sold a collateral management solution. They want to get away from sending emails and faxes, using spreadsheets and being completely reactive at managing collateral.

The Emperor’s New Clothes can be likened to the tale of optimisation and its so called importance; a story about a situation where “no one believes, but everyone believes that everyone else believes’.

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