I recently returned from the annual FTF DerivOps conference in Chicago. As always, it attracted professionals within the industry who came together to discuss the current state of collateral management, clearing, regulation and other topics related to derivative operations and processing.

Unsurprisingly a lot of the focus was on Collateral due to the changes in regulation, and there were some common, interesting themes – the importance of straight-through processing, the power of collateral optimization, and collateral velocity and how the movement of collateral and timeliness have improved. But the theme wasn’t about how everyone was benefiting from these, it was about how very few have these things — despite the amount of innovation and advanced technology available in the market across Collateral workflow, optimization and even front-office, pre-trade analytic tools.

These are all seen as nice to have’s right now as firms make their ascent up the Everest of regulation to ensure they keep themselves in good stead, a journey which has become tiresome for most.

From our own analysis and from what we have seen both from other research and the comments at DerivOps, approximately 3% to 5% of the market were ready for the new variation margin requirements on March 1, which despite some of the hazy regulatory changes, are now subject to delayed enforcement until September 1. Some very large dealers even reported they would only be 25% compliant with the new rules as of May 2017 – and some of these firms also have the initial margin deadlines looming. I don’t think I would be the only one to wonder whether we may see a Déjà vu come September 1.

For some, the changes that have happened in the Collateral world in the past 18 months are seen as several steps forward in regard to control, regulation and introduction of new technology. First, the regulators have focused on the importance of exchanging margin on uncleared OTC derivative transactions, with the result ensuring the implementation of processes that will significantly reduce the level of risk that existed until now. Second, advances in technology give firms powerful tools in Collateral workflow, regulatory reporting and optimization.

But with any two steps forward there is unfortunately generally one backward, and for most in the market, the changes in regulation have in effect caused a step backward. Why? Process. By introducing the new regulations, firms who trade but don’t clear their OTC derivative transactions are subject to daily variation margin exchange, and for the larger firms, daily initial margin came into effect September 1, 2016 and continues to roll through each year until 2020. Couple this with the FINRA 42.10 rules which are following in the footsteps, in a market that previously never conducted daily margin exchange as a market standard process, and the result is both complex legal and operational problems.

As one type of risk is removed, another emerges – Operational risk.

The introduction of the new rules gives firms three main options:

1.     Centrally clear. There has been a push to centrally clear over the past 9 months with IHS Markit noting an 800% rise in NDF flow through their MarkitSERV platform, and a CCP offering similar statistics on its website. Clearing presents a lot of benefits across margin, capital requirements and operations, and for those who already clear, it is less complex.  But establishing a connection with a CCP or Exchange for larger firms who don’t currently clear or with an FCM for the buy side, this takes time and effort. And for some smaller firms who don’t have to clear, it can often be seen to be cheaper and quicker to manage the flow bilaterally.

2.     Manage it bilaterally. This is where a lot of problems are coming to light due to unsuitable existing installed technology, an increase in manual processing and complexity in repapering agreements. These have led to some firms reducing their counterparties to reduce the amount of Credit Support Annex (CSA) relationships.

3.     Stop trading. It seems a rash decision, but it has been seen from our experience with a few clients who have reduced trading in certain products due to them running some rudimentary total cost analysis and recognizing that the total cost of the trade is just too close to that of their potential return.

From my understanding and based on discussion with our clients, most processes were, or still are, being done manually, with multi-layered fragmented processes across teams, functions and locations with multiple manual sign-offs. Manually drafting emails, manually drafting SWIFT and manually reconciling in Excel. The risk for error is high, and the performance of these processes is low — with lots of incidents and therefore hours of post-incident reviews which, from my experience, turn into an act of Congress without ever fixing the source of the problem. I’ve seen it before, too, where firms work off ‘average’ process performance.

If you dipped your left foot in boiling hot water, and your right foot in freezing cold water, on average it will feel OK; but in reality, you will burn one foot and freeze another.

I won’t even begin to get started on process scalability and future proofing for growth….But it doesn’t have to be like this. If you get your process right and you have consistent STP with automated controls built into your back-end processes, then the time and money factors are less of a burden; and to achieve this you need sound technology.

As firms look at possible solutions, the world’s most used collateral management tool — Excel — is falling very short! It certainly serves a purpose in some institutions and has its benefits but is not an automated or controlled solution, doesn’t have version control in large institutions and while utilized widely across the industry as a process tool, it is only as good as the person who has designed the way it works. I know I wouldn’t be the only one to say that from experience those people who designed those processes move and take their knowledge with them. I’ve been guilty of that exact thing myself in the past.

There has been a host of technology introduced to the market which has been widely under-utilized to date, in my opinion. It’s very easy for me to say that CloudMargin is the best platform to adopt.  I will always be biased toward my own product, and I’d be lying if I said that we are the only firm who offers most of the functionality we provide. That said, there isn’t anyone else in the market who can offer a collateral management workflow solution like we can in terms of our technology as an agile, integrated, single version SaaS solution. This allows us to run continuous development and adapt to changes in market regulation, making and deploying changes in the same week which are shared across the whole user community. This is somewhat of a revolution in the way in which people have historically looked at, and managed, their technology.

From my own experience, alternatives such as in-house or enterprise technology come at a high cost of support and maintenance and long deployment periods. Quite often tactical work-arounds due to lack of time or resources end up becoming the strategic process and just add in additional operational risk – particularly from a business continuity perspective. Another alternative, outsourcing is used widely across the industry, but a lift and shift of your operations doesn’t necessarily make it more controlled, and it costs. You wouldn’t outsource your front office so why outsource your back office? As a SaaS platform, there is no hardware for you to install and no software to manage, and the result is lower expenditure.  I can say from experience we can measure our implementation timeframe in days or weeks, not months or years, and at a much cheaper cost. If you’re concerned about data security then you’re right for correctly assessing your firm’s external risks, but in our cloud, the data is safe and is fully SOC1 and SOC2 compliant. Couple all of this with our best-in-breed collaboration with firms across the market who offer clearing, optimization and messaging, and CloudMargin can help you take that further step forward instead of backwards.

If anyone has a question around the new regulation or the looming ones, their own collateral management processes, the power of SaaS or if you just want a shoulder to cry on about an Excel spreadsheet crashing on you last week, then please reach out to any of us at CloudMargin, and we’d be happy to talk.

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