As worldwide demand for collateral increases, the collateral management services market has naturally had to undergo restructuring to accommodate and stay ahead of this demand. These services primarily function to ensure that all collateral obligations are met and that the institution has sufficient capital to cover all these obligations when due. The 2008 crisis put into motion a series of regulations that now demand a higher quality asset composition held on balance sheets. These reforms extended to the derivatives markets as well where borrowers now must post an incremental level of high quality asset collateral for their initial margin. The last moving piece in today’s collateral management landscape is the shift in risk appetite and preference of lenders where most now look to conduct secured transactions instead of the unsecured ones. These demand and supply side shifts are now pushing firms to broaden the scope of collateral management services from being just a balance sheet asset manager to viewing asset management from the perspective of collateral.
Until recently, the market for collateral had been highly fragmented due to investment banks focusing on their front office operations and allowing them to dictate the inventory held in the back office for collateral management. These front office operations are generally defined by asset classes across geographies which in turn create the supply of securities available as collateral. In addition, when the industry was still in its nascent stages, institutions didn’t devote many resources into optimizing the collateralization costs. As trading activity increased however, these costs became a larger portion of P&Ls and so firms have now mobilized resources to improve cost management infrastructure and processes of collateral management. These resources have now come to include tools that collate and aggregate information across multiple jurisdictions and geographies, optimize the allocation process of collateral and partnerships that aggregate securities via collateral movement.
The optimization of collateral is a process where the lender aggregates and uses information on the borrower’s collateral availability to maintain an allocation that optimizes costs and allows for efficient collateral movement. When tools to improve this optimization are built, their end goal is to allow for greater information intake across the multiple geographies the bank has securities inventories in and generate a recommendation algorithm that produces an output for minimal time and cost. Going forward, collateral management services are likely to go beyond just executing obligations that have been agreed to in prior trading days. Indeed, there is a greater push to allow intraday changes, collateral forecasts and projections and collateral calls to be built directly into these algorithms that automate the work flows for the lender and provide a quicker, less error-prone experience to the borrower.
In terms of developing aggregation dashboards, custodians today are now attempting to implement a platform with a single system that allows the borrower to view its posted collateral across multiple geographies and legal entity name differences. As an example, if Company A has an investment banking unit and a securities unit held separately, the customer would be able (with the right permissions) to deploy their collateral between the separate legal entities if needed. Furthermore, some of the largest custodians are also making an effort to allow customers to view all available collateral, completely agnostic of who the custodian is. In instances where the lender has activities in multiple jurisdictions where their preferred custodian doesn’t have operations, this can be a large step forward in enabling these borrowers to manage and optimize their collateral.
While the industry is still evolving and technology still spreading its roots, recent corporate endeavours have been brought about by demand and supply changes in the collateral management services industry. As the infrastructure continues being incrementally improved, there is significant potential for a business model similar to the manufacturing industry with regards to the “just in time” production technique. In the years to come, there may be a concerted shift by borrowers into “just in time” collateral if the single view technology affords them the timing flexibility to seamlessly deploy collateral across jurisdictions.