How Do You Do Your Laundry? – An Analogy With Collateral Management

When it comes to an increase of automation in your Back-Office operations, one can easily assume that, like the vast majority of institutions which are required to exchange margin today, collateral management is achieved typically via spreadsheets and emails.

Especially for buy-side firms, collateral management is considered as a back-office operation mainly concerned with daily margining and most prevalently, reporting.

This manual process can become unsustainable with the increased complexity of regulation (EMIR, BCBS 269 (Basel Committee on Banking Supervision etc.,) and the increased amount of collateral required in more and more transactions.

Don’t worry; you are not left alone trying to survive in the collateral management jungle! Large sell-side institutions, traditional software vendors and cloud-based technology companies will be able to assist you with the solution which will best fit your requirements.

What do you need to consider if you want to implement a solution that will automate your collateral management workflow? The answer to this question will depend on your type of organisation (bank, asset manager, pension fund, insurance company, corporation…) and the volume of collateral you need to exchange on a daily basis.

What are my different options? How do you do your laundry?

Don’t get me wrong…collateral management is not about laundering but rather about the different options you have to wash your clothes. Do you have a washing machine at home? Do you use a dry cleaning service or do you go to the laundrette (LaundroMat) nearby? For collateral management, strictly speaking, we would typically use only one of the below three options.

When it comes to choosing a collateral management solution, it is important to remember that you will only be able to do your ‘laundry’ with one of the below three options – How will you be doing your laundry?

1. Dry cleaning only? Do you outsource?

A handful of the largest broker-dealers provide collateral management outsourcing services.
Outsourcing will generally make sense if volume and complexity are high. This complexity could refer to optimisation, trading and transfer of collateral which takes into account funding costs, applied haircuts, eligibility criteria, possible re-use and alternatives – all of which demand a high level of resources, increased workload and of course an increase in cost.

Maintaining compliance with new regulations is also another key challenge impacting collateral management today. Efforts to maintain compliance place increased pressure on the day-to-day workflow of asset managers and errors can be costly both in terms of fines as well as the lasting reputational damage that non-compliance may create. These are few reasons as to why firms would want to outsource their collateral management activities.

Delegating the activity to a third party provider usually comes with a high price tag, which can be compensated by a reduction of your internal resources. A 2015 report on Collateral Management Outsourcing from Sapient clearly showed that the general outsourcing costs increased as the asset under management increased. As the requirement for more collateral increases, it is certainly a factor to bear in mind.

2. A washing machine at home? Shall I install an on-premise solution?

Traditional collateral management vendors have been offering such solutions since the late 90’s and have been evolving in order to meet new regulatory demands and business requirements, especially post-crisis 2008. If you intend to install a vendor solution in-house, there a few things you need to bear in mind:

• Incumbent technology vendors have traditionally addressed their solutions to large Tier 1 institutions, leaving behind the vast majority of the market with very little (if none) automation.
• Their clients with large collateral management requirements are usually able to pay the price that goes with such incumbent technology solutions.
• On-premise software installation will typically require:
o Long implementation cycles
o Internal resources during the course of the project and ongoing maintenance basis which will incur costs
o Bespoke integration in order to meet in-house specificities, as well time, costs and resources to install the updated software versions
• Maintenance of an installed software: technical support is not always granted and you may need to pay extra to receive a dedicated support

For the partisan of on-premise installation, the following advantages are usually felt by organisations:

• The feeling that you keep control (of the data, the support, the upgrades…) which usually comes with an increased workload and a higher price.
• For certain applications, you might not be relying on the Internet to access your data, and therefore prefer to opt for in-house. Typically, for a collateral management workflow automation software, you would still be required to issue calls and receive collateral in an electronic format (email, SWIFT or AcadiaSoft for the most advanced solutions) and this statement might therefore not be applicable).

3. Shall I use a laundrette (LaundroMat)? Is a third-party SaaS solution good for me?

As discussed, the new regulatory landscape is significantly impacting all users of collateral. The buy-side has reacted to these changes and associated increases in expense by placing far greater emphasis on the effective management of margin with a bias towards an enterprise-wide, centralised collateral programme to reduce risk, ensure optimal collateral usage and control cost. Systemic solutions facilitating the realisation of these objectives have historically been limited to either full outsourcing or purchase and implementation of third party software. Neither alternative has proved popular with a majority of buy-side institutions that continue to manage their collateral programme on spreadsheets to avoid the well-documented concerns associated with these options.

By definition, using a ‘laundrette (LaundroMat)’, a third party solution, you may feel like you are relinquishing a small part of control, and this can seem scary. One argument frequently raised against third party hosted solutions is the concern of security due to the handling of delicate and sensitive information off premise.

The truth is that a third-party company reputation is based on their security so it becomes integral to the product. On-premise software could leak like a sieve, with vendors knowing the reputational damage of data security issues will lay solely on the company using it, and not on the vendor themselves. Therefore, one could suggest that a third party SaaS security is a higher priority for the vendor than that of an in-house system.

One reason that a laundrette (LaundroMat), and is this case third-party SaaS solutions, are more favourable is because the user is not required to pay for any additional hardware: there is no software that needs to be installed and there is no need for costly IT teams to oversee maintenance and integration of the system into your environment – as you would need to do if you maintained your own washing machine (on-premise solution).

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