Collateral Guide 2024

TO ACCELERATE CHANGE, WE CONNECT YOU TO EXPERTS AROUND THE WORLD.

4 Foreword | Eileen Herlihy, global head of trading services sales at J.P. Morgan, presents the current year’s collateral management report.

5 Adapting to a new world | Increased volatility, rising interest rates and growing regulatory demands mean growing margin requirements and increasing complexity. Is this a spur or a headwind for better collateral management?

10 ABC’s of collateral management | Todd Crowther, Pirum’s head of corporate development and collateral services, and Scott Brown, head of origination sales - EMEA, engaged in a discussion about the intricacies of collateral management, exploring the challenges and benefits of this practice, emphasising the role of data analytics and emerging technologies in its optimisation.

14 Liquidity through collateral | John Templeton, managing director at BNY Mellon, discusses clients’ use of collateral for enhanced liquidity and how the organisation addresses this challenge for client benefit.

16 Driving optimisation through UMR | More than a year after the phase six deadline, the business cases for margin optimisation strategies that can ensure compliance while minimising costs is growing.

21 Trends in collateral management | In a video interview, Eileen Herlihy, managing director and global head of trading services sales, and Will Jeffries, executive director and APAC head of trading services sales at J.P. Morgan discuss the latest developments and insights in collateral management.

29 CCPs: better management or harder work? | As their use grows, participants have become more familiar with the pros and cons of CCPs, and the cost-benefit calculation underlying the decision to use one has become more nuanced.

33 Collateral schedules | Xavier Jacobée, co-head of triparty collateral services, securities services, at BNP Paribas, and Matthieu Leredde, product manager for triparty collateral services, securities services, discuss their approach to addressing client needs in collateral schedules using technology and data analytics.

36 Redefining collateral mobility | Charlie Amesbury of HQLAX talks about reshaping the concept of collateral mobility within the financial sector.

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Welcome to the 2024 Global Investor Collateral Guide

By Eileen Herlihy, global head of trading services sales at J.P. Morgan

Marketsand geo-political events have once again shaped much of the past year, with the elevated interest rate environment, after such a long period of low and stable rates, serving to create challenges and opportunities throughout the financial services industry. Notably several financial institutions came under the spotlight due to credit and liquidity challenges through H1 2023 which, once again, brought the importance of collateral management to the fore, ensuring credit exposures across all lines of business were well maintained.

Increased volatility and higher interest rates look like they are here to stay and form the key backdrop to the 2024 Collateral Guide. Increasing costs of funding and larger margin requirements heighten the importance and benefits of an effective cross enterprise optimisation approach for both the buy and sell sides and ensure there is an emphasis on efficiently utilising all potential collateral assets. The sophistication of the technology which allocates collateral has increased, as has the focus on structuring the most effective trade construct, blending traditional transfer of title arrangements with pledge, synthetic and CCP structures. As an industry we are driving and collaborating on many innovative solutions aimed at releasing harder to finance assets such as Money Market Funds, restricted shares or entering new markets.

The discussion around digital assets from a collateral and financing perspective has evolved significantly with the focus narrowing to natively

digital and tokenised traditional financial instruments. While many nascent digital asset services have come to market and demonstrate operational or economic benefit, speeding up client adoption is the key to ensuring their huge potential is realised. Another area generating much excitement is regarding how AI and machine learning can help drive efficiency, digital transformation and new revenue generating opportunities in the collateral and financing space.

From a regulatory perspective, focus is rightly now on next May’s transition. to a T+1 settlement cycle for transactions in U.S. cash equities, corporate debt, and unit investment trusts. The shortened time frame between trade execution and final settlement will challenge the post-trade world through reduced processing times, settlement risk and increased liquidity requirements, but there is potential to increase capital efficiency due to the reduced exposure over the settlement period. Further out, implementation of the Basel III ‘endgame’ proposals from 2025 will have far reaching impacts across the financing markets, including increasing the cost of capital for most and resulting in new output floors potentially impacting the supply of lending inventory from high-quality unrated funds.

All these topics and explored in depth in this, the 2024 edition of the Global Investor Collateral guide.

J.P. Morgan is once again proud to be lead sponsor, as we continue to demonstrate commitment to serving our clients and driving innovation.

Adapting to a new world

Increased volatility, rising interest rates and growing regulatory demands mean growing margin requirements and increasing complexity. Is this a spur or a headwind for better collateral management?

On the face of it, rising interest rates and increased volatility, which fuel larger margin requirements and more frequent requirements to re-post, should increase the visibility of the return on investment provided by better collateral management. In this reading, today’s tougher economic environment should make the benefits of optimisation more visible. Silos should disappear as fixed income, equities and derivatives business units

all see the need for a solution that integrates and compliments their various activities.

But today’s is also an increasingly tough commercial environment, thanks to rising interest rates, which are increasing cost of capital and increase scrutiny on liquidity.

“Everywhere there is a pressure on firms to manage finite capital, and their increasing cost to raise capital in a high-rate environment means that

their ability to mitigate heightened market risk and meet more stringent capital standards is becoming increasingly challenged,” says Todd Crowther, head of corporate development and collateral services, Pirum.

Seeking additional capital, banks issue equity, which becomes more expensive as investors demand higher returns to compensate for higher interest rates. The alternative, issuing debt, is now more expensive, too.

The wider context is years of regulatory tightening, most visible recently to smaller companies caught

by phases five and six of UMR, many of whom are discovering business models ill-suited to some of the challenges of effective collateral management at scale.

Meanwhile, the latest EU agreement on CSDR regulation passed in June, includes tougher preconditions for applying so-called mandatory buy-ins. This means collateral movements must be booked in timely fashion and effectively logged in real time with a custodian, increasing the need for connectivity between collateral and settlement systems.

“All this directly impacts the secured financing and collateral management activities which underpin every trading business. The higher capital impacts of regulation are layered on top of rising rates, and market volatility is significantly increasing costs of doing business. It’s a perfect storm,” says Crowther.

“Increased cost of funding augments the trend over recent years to focus on the various facets of optimisation – that is ensuring optimal allocation of collateral to counterparty and trade type, transacting through the right trading structure and minimising any drag through unfunded assets,” says Graham Gooden, EMEA head of collateral services, J.P. Morgan.

Regulation

Initial margin rules have added a third dimension to the process of balancing fund managers’ buying and selling activity with activities in a securities lending programme.

The traditional approach of divvying up a portfolio of internally versus externally managed collateral, and leaving it to a custodian to coordinate between lending and trading assets has been complicated by the need to consider which securities are needed to meet initial and variation margin requirements.

O’Delle Burke, APAC head of collateral services, J.P. Morgan, says that in Asia, for buy side firms meeting initial margin requirements, the main assets used are still G7 government bonds. “Beyond that, in some cases corporate bonds and equities are being negotiated as eligible collateral. In a few cases equities, namely the ones that are included in major indexes, may be accepted by counterparties”.

With buy side portfolios typically heavy on equities there is much to do to transform these to more widely available collateral.

Meanwhile, the enduring pinch points recur. A portfolio manager who needs to sell an asset that has been flagged for use for initial margin. A surge in demand for a holding by a broker dealer as a

INCREASED COST OF FUNDING AUGMENTS THE TREND OVER RECENT YEARS TO FOCUS ON THE VARIOUS FACETS OF OPTIMISATION

Graham Gooden, EMEA head of collateral services, J.P. Morgan.

borrower – which the manager is keen to meet to generate lending revenue – that is tied up meeting an initial margin obligation.

Questions of measurement plague evaluations of optimisation more broadly, too. On the face of it, reshuffling entire allocations, and substituting collateral across all clients, might be the most financially optimal approach to a firm’s derivatives book. But if the result is mushrooming operational costs, or dissatisfied clients, these consequences could quickly negate benefits from short-term funding.

“Unless an existing optimisation algorithm can take into account all or most of a firm’s requirements clients will think hard about the choice between using a triparty agent’s algorithm or one from a third party vendor,” says Eric Stovicek, Americas sell-side trading services sales, J.P. Morgan.

Given the scale of the task, the case for third party solutions, whose originators have devoted significant resources over many years, may trump those developed internally.

“Firms have realised that, by making a material commitment to transform collateral management and optimisation platforms they can expect a material return to justify the investment,” says Crowther.

He points to estimates by EY of annual returns for financial institutions on collateral optimisation in excess of ten times the initial investment, with 40% of benefits typically realised within the first year. Such initiatives also provide improved compliance, with current and future regulatory requirements easier to meet. Firms whose efficient collateral management makes them better able to service their clients – both internally and externally – enjoy a competitive advantage. “The final benefits accrue to improve a company’s risk profile, reducing operational, credit, market, liquidity, funding and counterparty risks whilst optimising financial resources and P&L performance,” says Crowther.

Fragmentation

UMR and a steady growth of CCPs is compounding the increase of bi-lateral trading venues and participants. From this increasingly fragmented selection, participants must build an effectively interconnected view.

Where possible, this means reducing or consolidating the number of collateral pools to improve efficiency and cut cost, says Ed Corral, Americas head of collateral services, J.P. Morgan. “We’re exploring how to reduce the need for clients

to bifurcate bilateral versus triparty margining and financing activities,” he says. “Where asset pools can’t be slimmed, demand increases for more robust algorithms to gain efficiency.”

More generally, growing demands are widening the scope of triparty services. “Structured finance in triparty has seen renewed interest from a number of angles,” says Gooden. “There are increasing numbers of asset- and mortgage-backed securities being financed as collateral. Triparty is being used to facilitate the collateralisation of SPV structures, such as asset-backed or collateralised commercial paper

AS A COLLATERAL MANAGER, OUR ROLE IS EXPANDING TO ADVISING CLIENTS ON HOW TO BEST WIDEN THE SCOPE OF COLLATERAL THEY ARE WILLING AND ABLE TO PROVIDE, OR RECEIVE

Jerome Blais, co-head of triparty collateral services, securities services at BNP Paribas.

programmes. Finally, we have seen more structured trades within triparty, such as contingent funding.”

“As a collateral manager, our role is expanding to advising clients on how to best widen the scope of collateral they are willing and able to provide, or receive, staying as optimal as possible and in respect of their internal risk management policies,” says Jerome Blais, co-head of triparty collateral services, securities services at BNP Paribas.

Getting information about collateral and where it is located early puts clients at an advantage, a point that is helping advance the case for the internal operational work required to improve optimisation.

“This is absolutely an essential element going

forward and has been a driver towards a wider adoption of triparty for the last decade or so. The current context can only accelerate this trend, as shown with the recent sharp increase of triparty volumes globally,” says Blais.

Trapped assets

Attention is growing over so-called trapped assets. ETFs, master limited partnerships, restricted shares or other securities not held at traditional depositories are hard to unlock for triparty financing.

“It’s certainly becoming imperative that banks are able to finance those utilised or underutilised assets on their balances to offset the unceasing changes

Routes to interoperability for DLT

DLT (distributed ledger technology) solutions provide an increasing focus for banks keen to optimise inventory as efficiently as possible at the same time as controlling costs.

In theory, DLT has the ability to materially improve collateral velocity for participants and cut down the time and money spent on cross-custodian realignments.

Standardisation is one solution to facilitate progress in this sector, but a single-sized blockchain solution doesn’t necessarily fit all applications. So, increasingly, efforts are focussing on ensuring that the range of solutions that emerge, operating on a variety of blockchains, can interoperate.

This will be a key focus point if ledger solutions are to prove a use case that generates value now and can grow easily to harness economies of scale in the future. The portends are good. In the first case, a sector with common sets of investors with matching ambitions, where ledgers have complementary use cases, provides a supportive environment.

Challenges

But there are challenges. Currently, there is a range of ecosystems that vary, based partly on how tech stacks and data systems are designed. The industry needs consensus around things like workflows and transition states to help them connect. DLT networks must be able to share data more easily by developing cross-chain standards - leveraging either peer-to-peer or intermediary solutions.

So, interoperability will make all solutions more attractive to users. The industry also needs to develop multi-asset or multitoken transaction solutions, so that the owners of baskets of securities can be exchanged across, as well as within, ledgers.

Charlie Amesbury of HQLAX points to work by the company to ensure their digitised collateral is compatible to exchange versus both fiat and digital equivalent currencies. “In the digital cash space, in particular, we have been working alongside market leading providers in Fnality and Onyx by J.P. Morgan,” he says.

“Getting the industry consensus around [Onyx] will help bring different parties together along the digital journey and leverage the utility set-up for different utilisation,” says Burke.

“Pirum is moving to support these new initiatives by extending our platform’s interoperability and building forward compatibility so that firms use and leverage their existing post-trade infrastructure, without the need to re-platform,” says Crowther.

Regulatory clarity

Clarity on the regulation and governance of DLT networks will foster wider adoption and greater interoperability.

Following the boom-bust ride for investors around the world in cryptocurrencies since 2021, regulatory scrutiny of the blockchain has focussed here, with many companies providing asset servicing solutions on the blockchain – who are themselves, nothing to do with crypto – pulled in for close inspection.

in regulatory capital requirements,” says Burke, pointing to the introduction of BASEL IV as the latest significant development in Asia.

But Benoit Uhlen, global head of MFS relationship management, securities services at BNP Paribas, says the importance of trapped assets is limited, compared to volumes of general collateral composed of standard assets such as fixed income assets or equities, in part because trapped assets are unlikely to be eligible for most collateral takers. “Banks and brokers already are showing, and will continue to show, appetite in refinancing such positions, but in this context, access and velocity of such assets is less of an issue,” he says.

“In APAC there is an increased urgency to come with practical and efficacious collateral solutions for local markets, where securities are being traded but are not yet able to be used as collateral, especially for cross-border financing, such as in mainland China, India, Indonesia, and Malaysia. In all these places, J. P. Morgan Collateral Services is conducting due-diligence assessments,” says Burke.

More than ever, then, efficient management and optimisation can drive substantial savings by minimising liquidity costs, reducing funding costs and maximising capital efficiencies. This is becoming more mission critical given rising interest rates, increased market volatility and rising capital costs.

But a wider, more supportive, regulatory ecosystem is developing, nonetheless. The final version of the EU’s Markets in Crypto Assets Regulation (MiCA) has provided an important step forward here.

While MiCA focuses on stable coins, unbacked assets and crypto asset service providers (CASPs), it includes provision for other digital assets, via the Distributed Ledger Technology (DLT) Pilot Regime. This provides a ‘regulatory sandbox’ to allow financial institutions to experiment with their core services (such as trading and settlement), as well as explore the new technology in a safe environment.

In addition, the Pilot Regime, which began receiving applications in March 2023, provides financial institutions with exemptions from certain regulations. Together, the provisions aim to support innovation and foster a growth in the number and

range of products and services employing blockchain technology and tokenisation.

In July, the UK launched the consultation for its digital securities sandbox - its first financial market infrastructure sandbox – which follows the success of the Financial Conduct Authority’s Regulatory Sandbox and Innovation Hub.

One inherent challenge when it comes to regulation, meanwhile, is the uncertainty of how DLT technology, or its application, will develop. This is one reason among many for participants to remain nimble and flexible as the sector evolves.

“Our solution is fully integrated into existing infrastructure and the legal frameworks that govern that infrastructure. In addition, through our trade associations, HQLAX are active supporters of regulatory progress that brings clarity to the market on new technologies,” says Amesbury.

“IN THE DIGITAL CASH SPACE, IN PARTICULAR, WE HAVE BEEN WORKING ALONGSIDE MARKET LEADING PROVIDERS IN FNALITY AND ONYX BY J.P. MORGAN”

Charlie Amesbury, institutional sales, HQLAX

ABC’s of collateral management: Analytics (Data), Benefits, and Challenges

Global Investor spoke with Pirum’s head of corporate development and collateral services, Todd Crowther and the head of origination sales - EMEA, Scott Brown on collateral management challenges, benefits, and the role of data analytics and emerging technologies in optimizing it.

Optimization Opportunity

Looking at current industry challenges, collateral optimization presents a major opportunity for firms to improve profitability and performance, decrease pressure on finite financial resources like capital, reduce specific and systemic risk as well as improve adherence to an evolving regulatory landscape. Many firms within the securities finance industry are already harnessing ways to drive collateral optimization which goes some way to achieving these objectives. With that being said, the industry challenges rather than abating, appear to be growing. A rising rate environment and heightened market volatility events (see the LDI crisis), for example, have resulted in further pressure on firms’ profitability and financial resources. In addition, new and evolving regulatory initiatives have added additional layers of complexity for firms to remain compliant and operationally efficient. These evolving initiatives include increased mandated central clearing, expansion of mandatory uncleared OTC margining, implementation of shorter settlement cycles and the adoption of new standardised risk approaches such as the new BASEL IV IRB and TWD regimes.

Collateral Challenges

The impacts of a heightened regulatory and markets environment means that the cost of doing business

for participants has materially increased. The cost of doing business for collateral management includes the need to automate the posting of more margin to more participants, across more products and an expanding set of locations. In addition, this must be done in the most efficient way possible in order to minimise the use of excess capital and its associated costs. Given that secured financing and collateralised trading activities represents the largest non-FTE cost to support secondary markets activity, firms are now viewing efficient collateral management and optimization as mission critical to not only address these rising costs but as an opportunity to drive substantial savings. These savings can be achieved by minimising liquidity costs, reducing funding costs and maximising capital efficiencies in a drive to improve returns. Enhanced efficiencies also enable firms to better support their businesses by reducing risk, improving service capabilities and enabling future growth. Pirum believes that through the effective implementation of advanced technology to support better target operating models, firms can address both these challenges and achieve these benefits.

Implementation Options

When considering the benefits to be achieved, how should firms consider the cost to adopt best practice collateral management and how should

they consider the alternatives between a build versus buy approach?

Firms are seeking to reengineer their enterprise and transform platforms to address a series of collateral challenges and requirements. Firms aim is to streamline collateral management processes to break down internal silos in order to address operational risk, add scalability and improve decision-making processes to better manage finite resources on an enterprise level.

The decision to build or buy boils down to a number of factors which, Crowther states, is ultimately a decision firms make based on four main factors including return, cost, timeframe, and implementation risk. In addition, firms need to also consider the future landscape based on the emergence of new technology such as artificial intelligence and blockchain. Firms will wish to be forward compatible or leverage these new technologies as they seek to better digitise workflows, streamline data and enable more realtime collateral management.

ROI Upside

From a top line perspective, it has been estimated by various consultancies such as EY and PWC that firms benefit from an upside of 10x-15x the return on investment where payback is achieved typically within the first year on ~40% of projects. Additional benefits include improved regulatory compliance in order to better meet both current and future regulatory requirements such as BCBS 248 & Regulation YY. Many firms who are now optimizing their collateral management processes indicate that it brings an increased competitiveness in the marketplace, which in turn enables these firms to better service their clients. Finally, the adoption of new collateral management technology also provides the opportunity to improve a firm’s riskreturn profile by not only increasing top line revenue but also by reducing operational, credit, market, liquidity and funding risks.

Cost to Implement

From a cost implementation perspective, firms need to be aware of potential complexities of implementing an enterprise-level solution which has the potential to centralise activities for a firm but often requires strategic investment and transformational change. Taking into account the cost of connectivity, firms need to consider the cost of opening and keeping

the lines open, with a particular focus on wide diversification of collateral venues such as triparty, bilateral and CCPs. Furthermore, given the mandated shortening of settlement timeframes, especially with the US SEC migration to T+1 set for next year, firms need to establish this connectivity on an intraday basis in order to better support accurate and timely processing of margin and collateral activities. Finally, looking at the data side, firms need to think about digitisation, real-time data management and the ondemand intelligence required to support optimization for complex objectives like LCR, NSFR and RWA.

To this end firms require flexible implementations, and with this in mind, Pirum has collaborated with J.P. Morgan and Euroclear as a ‘connectivity agent’ to offer STP directed allocation capabilities for firms that choose to use an in-house (or third-party licensed) optimizer, or alternatively, Pirum and BNY Mellon has formed a strategic collaboration to offer firms a more comprehensive, managed service option by supporting an ‘outsourced algo’ solution via BNYM’s ECPO service.

The ECPOConnect service integrates two production-ready platforms that complement each other whilst enabling each company to more capably solve a key client ask: deliver a turnkey, end-to-end portfolio optimization solution for their enterprise.

Time-to-Market

Looking at the ongoing costs of adopting such enhanced collateral management processes, firms need to consider the burden of integration, maintenance, and the need for continuous investment into technology. With so much connectivity and data to integrate, it is important for firms to consider readily available solutions, even if plugging into an existing network, given the fact there are multiple triparty agents, over 60 CCPs and Exchanges as well as 100s to 1000s of bilateral counterparts. Additionally, firms need to be aware of the hidden cost of maintaining status quo, the continuous investment required to ‘standstill’ as the complexity of the business landscape changes as well as the industry adopts new emergent technologies such as DLT, AI and machine learning.

Risk of Delivery

From an implementation perspective, the ability of firms to create transformational change can boil down to an assessment of the risk of adoption. An

internal build may look more attractive from a cost perspective however existing, proven technologies offered by vendors and infrastructure providers can be less risky (and costly) to implement. Where firms aim to deliver highly configurable, resilient and scalable solutions, they should consider options with an established track record of delivering and supporting enterprise-level requirements. Extensibility should also be a consideration as a

means to expand across product silos, geographic locations and different business lines. Looking at the ability to scale, firms also need to assess the ability to solve big data problems, which can be done through collaboration with the right partners to reduce execution risk and enable the solution to scale quickly to achieve faster time to market.

Just like learning your ABC’s, we hope to have made this complex topic easier to understand.

Todd joined Pirum Systems in 2017 as Head of Collateral Services & Corporate Development where his role includes firm strategy, product innovation as well as corporate development including M&A and partnerships.

Since joining Pirum, Todd has spearheaded Pirum’s CollateralConnect platform, a collateral management solution for the market supporting full front-to-back collateral automation, digitisation and enterprise-wide optimization.

During a 20-year career in investment banking, Todd has held a number of senior sales & trading roles at PaineWebber, ING, Deutsche Bank and Nomura where he built and ran a number of successful businesses in Securities Finance, Cash Prime Brokerage, Synthetic Prime Brokerage and Delta One.

Todd holds a Masters in Finance from London Business School as well as Bachelor’s Degrees in Economics and Asian Studies.

Scott joined Pirum Systems in 2018 as a Business Development Manager and now serves as the Head of Origination Sales EMEA, boasts over two decades of expertise in Sales, collateral management, securities processing, and project management.

Scott’s career began at Deutsche Bank in 2001, spanning front, middle, and back-office roles in Securities Finance. He rose to Vice President of Product Solutions at J.P. Morgan before joining Pirum Systems. Before Pirum, he excelled in agency collateral management at J.P. Morgan and led clientfacing teams at RBS and Barclays, specialising in OTC and ETD. His career is marked by a strong market presence, impeccable reputation, and consistent exceptional results.

Scott is celebrated for his unwavering commitment, stellar results, and expertise in Sales, collateral management, and securities processing, particularly in project management. He’s adept at assembling and leading client-focused teams known for their creativity, energy, and goal-oriented focus.

Todd Crowther, head of corporate development and collateral services

Scott Brown Head of EMEA origination sales

Liquidity through Collateral

Global Investor interviews John Templeton, managing director, BNY Mellon to discuss how clients are currently exploring collateral as a means to enhance liquidity in the current financial environment, and how the organisation addresses this challenge to benefit its clients.

Evolution in the global markets has created an opportunity for clients to align their securities finance and collateral management activities in order to meet their goals.

Collateral management has always been a critical component of the securities lending industry. In a securities lending transaction, the lender receives eligible collateral prior to or simultaneous to extending the loan. This collateral provides an important mitigant against the risk of counterparty default. And for many clients in securities lending, cash collateral provides an investment opportunity which can provide

IT IS INCUMBENT UPON THE PARTY RECEIVING COLLATERAL TO ENSURE THAT THE GUIDELINES OF THE COLLATERAL SCHEDULE ACCURATELY REFLECT THE FIRM’S RISK TOLERANCES. IT IS SIMILARLY IMPORTANT TO ENSURE THAT THE OPERATIONAL PROCESS TO RECEIVE THE COLLATERAL IS ALIGNED WITH THEIR PERFECTION OF SECURITY INTEREST UNDER THE TRADING AGREEMENT.

additional returns outside of the intrinsic value of the assets on loan.

It is incumbent upon the party receiving collateral to ensure that the guidelines of the collateral schedule accurately reflect the firm’s risk tolerances. It is similarly important to ensure that the operational process to receive the collateral is aligned with their perfection of security interest under the trading agreement. For many securities finance transactions, utilising a triparty collateral management provider is the preferred route to align operational efficiency and collateral eligibility analysis.

With the adoption of the uncleared margin rules, which requires the collateral be held at a third party, more firms have requirements to post collateral and have sought to meet those same goals of operational efficiency and alignment of collateral eligibility. This has led to a significant shift with many firms that have traditionally operated exclusively on the “receiving” side of triparty collateral management also becoming collateral providers on the platform.

Since the margin rules for derivatives prescribe what types of collateral may be delivered to meet collateral eligibility requirements, firms are looking for opportunities to better align their investment strategies with the margin rule needs. For example, if the provider of collateral does not naturally own assets that meet their margin needs, they can either alter their

investment strategy (with the resulting impact to performance) or seek to engage in securities financing transactions to source eligible collateral to post.

This creates additional risks and opportunities for clients.

First, many beneficial owners participate in securities lending through an agent lender. A critical part of optimising the collateral posted to secure transactions is ensuring that those assets do not have intrinsic value.

If the securities do have intrinsic value, the agent lender can lend them to generate those revenues and collateral without intrinsic value (i.e., GC) can be utilised to post as collateral. Many agent lenders offer opportunities to clients to “release” a portion of the cash collateral portfolio to utilise for general corporate purposes. The economics of doing so for securities with intrinsic value typically compares favourably to raising overnight or ongoing financing.

Alignment between the custody, agent lender, and triparty collateral management is crucial to ensuring that friction does not disrupt lending revenue.

Second, once the portfolio of available assets to post as collateral has been identified, clients can then compare their available assets to the collateral requirements to optimise which should be delivered to address each obligation. If the client is utilising a triparty collateral management provider, they can further optimise across obligation types – ie, derivatives and self-directed securities finance trades.

For clients who have the scale and priorities needed to invest into this process, the result of their work is an ideal end state with clients realising efficiencies in their posting of obligations across multiple agreement types. They maintain securities lending revenues on their intrinsic assets, and other assets not needed for margin purposes. They also have the flexibility to reach financing counterparties, many of whom limit their bilateral financing activity for cost and risk discipline reasons.

At BNY Mellon, by integrating our solutions across collateral management and securities finance, we are helping our clients to meet their goals of realising revenues in their lending programmes while broadening their access to financing trades and counterparties.

John Templeton, managing director and global head of securities finance sales and relationship management for BNY Mellon Markets

John Templeton is a Managing Director and was named Global Head of Securities Finance Sales and Relationship Management for BNY Mellon Markets in January 2022.

John joined BNY Mellon in 2000 and, prior to assuming his current responsibilities, held a number of business development positions within BNY Mellon’s Markets, Global Collateral Services, Broker/ Dealer Services, Global Client Management and Securities Industry Banking divisions.

Driving optimisation through UMR

Under UMR phases five and six, which require the segregation of collateral posted for initial margin, the need to juggle margin requirements alongside trading and securities lending operations has introduced a new set of challenges for buy side firms.

The requirements have introduced a new level of complexity in terms of the number and range of relationships that need to be supported to facilitate

margin exchanges, and to calculate initial margin requirements.

The compliance task has focused attention on issues including the quality of data and its management, the robustness of margin models, the processes required to calculate margin on exotic instruments, and how best to keep track of transfers in ownership of collateral. It has also increased the

More than a year after the phase six deadline, the business cases for margin optimisation strategies that can ensure compliance while minimising costs is growing.

value of coordination across collateralised business areas, from cleared and OTC derivatives, to repo and equity finance, and added scrutiny on how operations and treasury functions interact.

“In practice, the vertical integration of tasks provides an efficient and stable service from end to end,” says Benoit Uhlen, global head of MFS relationship management, securities services at BNP Paribas. He points to the example of custody lending, which allows participants to coordinate the management of corporate actions and coupondividend payments, making processes completely transparent between lent and un-lent positions.

“The quality of a lending service provider will

THE VERTICAL INTEGRATION OF TASKS PROVIDES AN EFFICIENT AND STABLE SERVICE FROM END TO END

now not only be judged on its capacity to lend at the adequate level and generate the maximum return, but also on its ability to identify the optimal lendable scope, based on the lenders’ profiles and characteristics,” he adds.

Recent market volatility, meanwhile, has illustrated the business case for improving STP to deliver margin in a more timely and precise fashion. The need to be prepared for sudden increases in call volumes, or sharp spikes in collateral funding needs, has increased.

Benefits of automation

Automation has clear benefits in an industry that

Benoit Uhlen, global head of MFS relationship management, securities services at BNP Paribas.

is becoming increasingly fragmented, with more participants, and more products in more locations, requiring more – and more complex - intra-day collateral movements.

At the post-trade level compliance relationships must mature from calculating and monitoring initial margin requirements, to supporting fully executed documentation. This could take years.

“Having a platform that is able to keep track of assets across multiple activities - trading, lending and initial margin – is key,” says O’Delle Burke, APAC head of collateral services, J.P. Morgan.

Dynamic management of assets is required for optimal usage across these three spheres.

“Effective optimisation can hardly go without an optimal allocation of trades to counterparties, so as to minimise, where possible, the overall initial margin requirements. A sound usage of what-if simulations helps identify counterparties that will minimise the postings of initial margin, or determine whether some risk-reducing trades could trigger lower initial margin requirements,” says David Beatrix, head of OTC and collateral services, securities services at BNP Paribas.

Changing needs

And to work best, an optimisation solution, needs to be responsive to client’s changing needs, achieving effective mobilisation based on pre-set agreed parameters.

“Solutions for inventory management across margining and financing activities must be able to adapt in a timely fashion to shifts in asset types within a portfolio and changes in eligibility criteria,” says Burke. “This way, there is very little or no daily operational involvement from the client.”

“Fundamentally, UMR has increased the collateral management challenge for all market participants. Typically, impacted institutions are now managing many more pools of more complex collateral and a much larger value of collateral overall, both held and pledged,” says Todd Crowther, head of corporate development and collateral services, Pirum.

“The challenge this complexity brings manifests itself in a number of areas, including exposure visibility, eligibility analytics, collateral mobility and the timeliness of data. Rather than ‘throw bodies’ at the problem, market participants are turning to technology vendors for better, lower-cost solutions,” he adds.

The situation isn’t helped by the high level of manual process – increasingly inefficient in an ecosystem that is expanding so quickly. “We are helping both buy and sell side build out connectivity and automation solutions to manage these challenges,” says Crowther.

Role for triparty

Given this growing focus on optimisation and liquidity, buy-side clients are calling increasingly on their custodians and third-party securities financing agents for integrated collateral management and transformation solutions. Triparty helped facilitate earlier stages of UMR; today, phase five and six require a fully scaled solution.

Ted Leveroni, global head of margin services, BNY Mellon says the company has seen significantly more

EFFECTIVE OPTIMISATION CAN HARDLY GO WITHOUT AN OPTIMAL ALLOCATION OF TRADES TO COUNTERPARTIES

David Beatrix, head of OTC and collateral services, securities services at BNP Paribas.

buy side adoption of triparty collateral management than was expected before phase five of UMR.

“While triparty collateral management was once considered a solution for the sell side, buy side firms realised they, too, could benefit from the collateral optimisation capabilities of triparty and enjoy the liquidity benefits that triparty solutions can deliver,” he says.

More buy side firms are now leveraging triparty collateral management beyond UMR, he adds. “Essentially, they are taking advantage of the infrastructure they put in place for UMR, for a broader list of collateral obligations, including nonregulatory independent amount, variation margin, and financing activity.”

Co-ordinated by industry bodies and working groups, protocols are emerging that, in turn, help companies smooth their internal collateral processes.

“Thanks to the work done in collaboration with ISDA and its UMR Custodian and Collateral Working Group, triparty agents have designed and implemented a robust operating framework that puts the emphasis on efficiency. Counterparties are required to produce daily undisputed initial margin amounts to comply with same-day collateral obligations, which has contributed to the improvement of the upstream processes,” says Jerome Blais, co-head of triparty collateral services, securities services at BNP Paribas.

Tasks for triparty agents or vendors may now include digitising collateral eligibility schedules and harmonising data from client and thirdparty systems to provide an integrated view. But employing triparty exclusively to drive compliance under UMR might be challenging in some cases, such as complex fund structures in Europe.

“During the implementation of UMR, while triparty would act as one of the instruments of the overall orchestra, there are also a lot of other crucial components,” says Burke, pointing to trade valuation, exposure calculation, margin call administration and dispute management.

Third party vendors also have an important role to play, meanwhile, as the UMR journey illustrates. Many firms that engaged vendors for initial margin calculation, as well as margin agreement and collateral management processing, have been able to leverage vendors’ expertise, typically built up through supporting multiple UMR phases. For smaller firms, who may be reluctant or unable to take initial margin management in house, this route has additional benefits.

With connectivity across a range of systems and

sources, third party providers should be able to take the headache of build and maintenance off the client’s plate, so that clients can focus on their core business.

DLT

One emerging solution through which third party providers may provide a significant boost to achieving UMR compliance is distributed ledger technology (DLT). In theory, DLT could speed and simplify UMR compliance by removing the need to physically transfer securities.

WHILE TRIPARTY COLLATERAL MANAGEMENT WAS ONCE CONSIDERED A SOLUTION FOR THE SELL SIDE, BUY SIDE FIRMS REALISED THEY, TOO, COULD BENEFIT

Ted Leveroni, global head of margin services, BNY Mellon.

BY DECOUPLING

The benefits of accelerated – or even immediate –posting of non-cash collateral became particularly visible in September 2022, when sharp falls in gilt prices, and the rush to sell assets to generate cash to post as collateral, created major risk event for UK LDI pensions.

Rapid price falls triggered multiple intra-day margin calls, and a rush to sell assets to provide cash to meet these: as participants sold gilts to cover losses on gilts, the crisis accelerated until the Bank of England intervened on 28 September.

“The LDI funds were solvent but they struggled to convert gilts to cash quickly without also exacerbating an already disrupted market,” says Burke. “The additional efficiency and liquidity from DLT would potentially help reduce the risk of procyclicality.”

The key to what DLT offers here is its ability to take away the need to physically transfer securities, instead transferring ownership on the blockchain, which is then visible immediately and simultaneously to everyone.

To support variation margin requirements, for example, clients of HQLAX can transfer the ownership of securities between each other for variation margin at precise moments in time, 24 hours a day. They can also extend the automation around these flows by adding programmable behaviour in their own margin management systems, or by working with HQLAX partners.

“Market infrastructure providers and vendors such as Pirum are working together to provide new services based on distributed ledger technology,” says Crowther, pointing to J.P. Morgan’s TCN Tokenised Collateral Network, BNY Mellon’s Digital Asset Custody platform, as well as work by Clearstream and HQLAX

AI and machine learning

But DLT’s potential to speed the transfer of non-cash collateral is not the only technology application set to drive optimisation forward.

AI and machine learning offer significant gains in enhancing efficiency and reducing operational risks.

“The benefits are already considerable: reducing operational cost and the risk of fails – meaning fewer fines – and expanding the time window, widening the access to collateral as it becomes more fungible,” says Crowther.

The rapid speed of change means that for this technological frontier, clients are looking to providers more than ever to reap the benefits in place of developing their own solutions in-house. Tapping the transformational potential of these technologies requires big investments and a long-time frame. At the end of it all, solutions need to work without hitch, as soon as they are deployed.

“The goal is to plug existing infrastructure into other services, making solutions as seamless as possible,” says Crowther. “Clients don’t want to build or re-platform, nor should they have to.”

Getting client buy-in for these means clear proofs of concept: demonstrations of how, for example, machine learning, when property applied, will improve post-trade reconciliation remediation.

“The best solutions span the whole enterprise, they need to be front-to-back, not spreadsheetbased,” says Crowther. He points to existing progress towards UMR forged by triparty, as a template: “We have 120 sell-side banks on our platform, a vast majority are pledging UMR initial margin via triparty mechanisms using Pirum’s existing pipes and plumbing. This allows them to agree and instruct margin, manage inventory, forecast requirements and self-direct collateral allocations through their existing operations.”

OWNERSHIP TRANSFER FROM THE MOVEMENT OF ASSETS, EXCHANGE CAN TAKE PLACE SIMULTANEOUSLY, IN REAL-TIME AND WHEN REQUIRED, WITHOUT THE NEED TO ACTUALLY MOVE THE SECURITY PHYSICALLY

Charlie Amesbury, institutional sales, HQLAX

THE BEST SOLUTIONS SPAN THE WHOLE ENTERPRISE, THEY NEED TO BE FRONT-TO-BACK, NOT SPREADSHEET-BASED

Todd Crowther, head of corporate development and collateral services, Pirum.

Trends in collateral management

In a video interview, Global Investor engaged in a conversation with Eileen Herlihy, managing director and global head of trading services sales along with Will Jeffries, executive director and APAC head of trading services sales at J.P. Morgan, to explore the latest developments and share their exclusive insights for collateral management.

Amelie Labbe-Thompson (AL)

Hello, and thank you for tuning in. I’m Amelie Labbe-Thompson, the Managing Director of Global Investor ISF. What you’re about to listen to is part of the 2024 edition of the collateral management Guides and features exclusive insights from J.P. Morgan’s Eileen Herlihy and Will Jefferies. William and Eileen, over to you.

William Jeffries (WJ)

Good morning. Good evening, everyone, depending on where you are in the world. Thanks for joining us today. My name is Will Jeffries, and I’m responsible for APAC Trading Service’s Sales here at J.P. Morgan. Specifically encompassing tri-party collateral management.

With me today is Eileen Herlihy, Global Head of

Trading Services Sales, also at J.P. Morgan. Today, we will be discussing the top trends in collateral management as part of the Global Investor Collateral Guide as we enter 2024.

Good morning, Eileen.

Eileen Herlihy (EH)

Hello Will, I have to laugh that this is a fireside chat. Given how many thousands of miles we are away from each other. But it’s good to talk.

WJ: Absolutely. Just to get things started. Can you please just give me a quick overview of what your role is and what J.P. Morgan Trading Services is?

EH: Yes, I think that the term Trading Services is a bit of a J.P. Morgan specialty term. We mean our Agency Securities Finance and Collateral Services businesses. We brought these businesses together in 2017, as we felt that it was much more holistic to look at these businesses together, given that we saw a lot of convergence and similarities across both these product sets. So, it made sense to bring them together and I run sales for Trading Services on a global basis.

WJ: Okay, perfect. Thanks very much for that. Now, J.P. Morgan recently conducted a survey with our clients, and one of the key questions we asked was, “What is your focus for collateral in 2024?”. The top three responses by quite some margins were - optimisation, new markets and new counterparties, all in that order. Does this surprise you at all?

FINADIUM RELEASED A SURVEY AT THE END OF LAST YEAR WHICH STATED ONLY ABOUT A THIRD OF LARGE GLOBAL ASSET MANAGERS HAVE CENTRALISED FUNDING DESKS OR CASH DESKS. IF YOU THINK ABOUT IT, THIS IS QUITE LOW IN COMPARISON TO THE SELL SIDE, WHERE I IMAGINE THE NUMBER IS NEARER TO 90% OR 100%.

EH: No, it doesn’t. In fact, if optimisation wasn’t on top of the list, I would have been shocked. In fact, I wonder if in any year we wouldn’t have had optimisation in the top three as something that our clients care about. If you look at the landscape in which our clients operate, clearly managing their balance sheets, their liquidity and their capital are key things that they have to do on a daily basis.

It’s been such a strong theme and people have been on different parts of that journey since the global financial crisis in 2008. The sell side has been very much at the forefront of this through setting up centralised funding desks, bringing together businesses that have traditionally operated in different silos to make sure they’re looking at their collateral optimisation holistically.

Our job as tri-party agent is to help them manage that in whatever process works best for them. Some clients want to completely do everything in-house, and we really need to provide the operational infrastructure around that. Alternatively, some clients need help, and they need us to help more directly in terms of how they build that optimisation engine.

So, we’re really there to support them. And then of course, new markets, new venues and new liquidity. These are topics we can talk about later, but have all been themes for optimisation for several years.

WJ: So potentially what we can take from optimisation for the sell-side, is that the job is never really done. How about the buy side?

EH: That’s very interesting. Finadium released a survey at the end of last year which stated only about a third of large global asset managers have centralised funding desks or cash desks. If you think about it, this is quite low in comparison to the sell side, where I imagine the number is nearer to 90% or 100%. The buy side has been very focused in recent years with the implementation of the Uncleared Margin Rules (UMR) as the various phases work through the system.

Going into 2023, we thought that this would be a year where the buy side could be given a little bit of respite. However, the gilt crisis at the end of last year in the UK was quite an eye opener for

a lot of the U.K. buy side. And quite frankly, it’s something that we talk to clients all around the world about.

As one client recently said, “We had plausible deniability the first time around. But if anything like this were to happen again, we need to be able to demonstrate that we’ve optimised our collateral processes.” So, it’s caused a lot of reflection with our clients and we’re starting to see them focus more and more on collateral optimisation and efficiency.

We recently pulled some stats from our tri-party programme looking at the composition of collateral posted by our buy side clients. As recently as two years ago, in July 2021, 90% of collateral being posted by the buy side was government bonds. Fast forward to two years later in July of 2023, that number decreased to less than 50%.

What we’re seeing now is buy side clients posting about a third of their margin in corporate bonds and then about 20% in equities. We’ve seen a very dramatic shift, in quite a short time frame.

WJ: That’s great colour, and it’s interesting to hear the key differences between the buy side and the sell side.

EH: I want to turn things back on you, Will, it shouldn’t have to be me answering all of the questions! We talked about the optimisation of new markets and new liquidity being important, but of course, you are on the ground there in Asia. Can you tell us what you’re seeing from a new market’s perspective there?

WJ: Asia is unique in that each jurisdiction has different rules and the region has a significant number of restricted markets. What that really means, is that many of these markets require innovative solutions to be able to support them as collateral and ultimately allow our clients to optimise their balance sheets. What’s interesting with these markets is that many of them, despite being considered developing markets, are very large and important markets that clients either have substantial holdings in or see significant opportunities.

When many of our clients look at their unfunded assets, a large percentage of these are sitting within Asia and can quite often considered

LOOKING FORWARD TO 2024 AND CERTAINLY IN THE CURRENT INTEREST RATE ENVIRONMENT, WE SUSPECT THAT THERE’S GOING TO BE A LOT MORE PRESSURE ON UNFUNDED ASSETS. WE’RE FIELDING MANY QUESTIONS ON NEW MARKETS AND SOME OF THESE ARE CHINA ONSHORE, INDIA, INDONESIA, AND MALAYSIA, JUST TO NAME A FEW.

trapped assets that can’t be financed or are difficult from a collateral mobilisation perspective. So they become a key focus.

EH: Interesting you say that, because I was talking to one of our US colleagues last night and comparing the amount of asks we get from clients on the Asian side versus, say, the LatAm markets; but it’s fair to say that when we go out and meet clients that it is Asia that dominates.

Can you be a bit more specific around which markets in Asia you’re seeing the most interest in?

WJ: It’s probably no secret about the areas we’ve been focusing on, and it is ultimately well aligned with our clients and their activity. South Korea, Taiwan, China and Stock Connect are all key markets that we’ve invested a significant amount of time in over the years, and that’s really been beneficial for our clients in helping them mobilise their assets.

Looking forward to 2024 and certainly in the current interest rate environment, we suspect that there’s going to be a lot more pressure on unfunded assets. We’re fielding many questions on new markets and some of these are China onshore, India, Indonesia, and Malaysia, just to name a few.

So that’s really what we see as being a key focus from our clients. I also want to mention that it’s not all about APAC. There are markets in EMEA, that we hear about as well, such as Saudi, Turkey and Israel as an example. Ultimately the challenge that we all face is that these markets have very different requirements and they really do require significant innovation.

EH: As you mentioned, these aren’t simple markets and it’s all very well and good that the borrowers have these unfunded assets that they want to be able to utilise, but what about the lenders? What’s in it for them? Why should they have to go through some such complex processes to bring in new collateral to the programme? Can you talk about the supply and demand dynamics with these new markets?

WJ: We’ve been seeing increasing interest from lenders to expand collateral, and again, that’s not a new trend, but it’s certainly something that’s been developing over the last few years and that’s really when returns are hard to come by. When [lending] supply outstrips demand, new markets can really act as a lever to extract further yield from lending portfolios.

So that’s one of the key focuses and one of the reasons our lending clients are looking at these markets, but they also provide a key differentiator for lenders. Lenders do need to satisfy themselves with the enforceability aspects of new markets. Given that many of the Asian markets are restricted, this includes being comfortable with pledge solutions but also looking at liquidation models that ensure that they can quickly and efficiently liquidate collateral should the need arise.

Once lenders are comfortable. There are also considerations on whether they are being compensated against the risk that they’re taking from a new market, particularly when the collateral might not be widely accepted by other lenders.

EH: Yes, but of course that’s incumbent upon the lender to extract the maximum value for that as well. Shall we move on to pledge now? You have talked about it quite a bit and from my perspective, we’re always wondering, is the next year coming going to be the year of Pledge?

It was 2018 when ISLA came out with their pledge GMSLA. If you look at from a European perspective, about 17 to 18% of collateral is posted under a pledge, and it’s been at that level for quite a while now and I would expect that number to be a little bit higher.

Lenders must satisfy themselves that any collateral that’s posted under pledge meets local

perfection requirements. But it is one of those topics that we talk to clients a lot about. Of course, there are challenges with Pledge - Does it work for UCIT funds and of course there are challenges for American borrowers.

If I was to try and predict themes for 2024, from a recent borrower and lender roundtable that we ran here, it seems that there was consensus around the table that they wanted the industry associations to focus on Pledge Back type of structures, and see if we can get some documentation in place to enable these structures to be more broadly used.

So, pledge and variations of pledge, I definitely think will be a theme for 2024.

WJ: That’s certainly consistent with what we’re seeing in Asia.

Now the third top response to our survey for 2024 was new counterparties. You also mentioned new venues as part of the sell side approach to optimisation. Can you just expand on these two points for me?

EH: I might skip the question on new counterparties and spin that one back to you, but I’m very happy to talk about the new venues. To be honest, this is multifaceted and CCP margining though tri-party is a topic close to my heart.

I used to work in our clearing business here at J.P. Morgan for the past 10 years before coming into this role and what we’re seeing in our clients, especially organisationally, is a lot of clearing and prime businesses coming together, and as we talk about this never ending journey of optimisation, people are saying, “I love Triparty for my stock loan and my repo, but why can’t I also use it to optimise my collateral at the CCPs?”.

Just to put it into context, there is about one trillion of margin held globally at CCPs. About 30% would be bank assets, and then the other 70% would be client assets. So, a non-trivial amount of margin that needs to be optimised. We are working with our clients across the globe to see if we can facilitate margining using a tri-party long box to deliver collateral to the CCP.

Of course, many clients welcome that because there is a lot of operational integration that needs to be done with each of the CCP’s. We have a

Optimization Mobilization Integration

mechanism where we have worked with a third party to facilitate the ease of integration.

WJ: What are you seeing from the CCP’s themselves? Are they ready to take non-cash collateral and how are they adapting to this?

EH: CCP’s accept non-cash collateral today, but there is a lot of inefficiency within the margining process. We are working with many of them, and I think there is an appetite to accept a certain amount of non-cash collateral, but one must also be mindful that the economic model for many CCP’s is that they generate a lot of their revenue from cash collateral.

I’m going to throw it back to you now on new counterparties. Do you want to tell us about what we’re seeing in Asia?

WJ: New counterparties are extremely important to the to the entire financing ecosystem. It’s particularly important for us as a tri-party agent because it creates a network effect for our clients. New lenders provide liquidity enhancement through introducing new sources of funds or securities which can help with overall liquidity of the market.

In instances of new borrowers, they provide new demand, which ultimately leads to better price discovery as pricing becomes more reflective of the market conditions. Perhaps most importantly, new counterparties provide optionality and diversification. This is particularly important for all our clients as they manage regulatory requirements and look for different counterparties with varying profiles and funding sources.

EH: What’s interesting about that, as we go and develop new counterparties throughout the book is the ability for them all to be able to trade with each other. Can you talk a little bit about how we focused on our global operating model?

WJ: J.P. Morgan has for a long time operated a tri-party system which has allowed clients to exchange collateral on one global system. We’re now starting to take that a step further. We have certain instances where collateral is operating in different environments. In Australia, as an example, we have an Australian onshore platform that contracts under Australian law and through our Sydney branch. In the US we have a U.S. platform and that’s contracting with our New York branch and it’s these various environments which have always been there and existed for local reasons, such as local contracting requirements.

I’m going to talk about this a little bit later, but we’re seeing a lot more regionalisation with local counterparties who want to open and trade with more global counterparties. So, we’ve had to think of ways to adapt to that. We have worked on a new legal process, where not only can clients exchange collateral freely on our international platform today, we’re now looking at how they can do that from our international platform to our Australian platform or from our Australian platform back to the international platform. This is really important where the U.S/ EMEA might be operating, and Australia might be asleep, but clients need to tap into various sources securities collateral which they can move across entities and time zones in a frictionless environment.

So again, from that perspective, it’s all about collateral mobilisation.

EH: Okay, thanks for that. I’m sorry I may have interrupted your train of thought. Should we go back to what we’re seeing specifically from an Asian perspective with new counterparties?

WJ: Yes. I think I was talking about optionality and diversification. It’s no longer necessarily about the loan and the spread of the transaction. And it’s been like this for a long time. Borrowers

NEW COUNTERPARTIES ARE EXTREMELY IMPORTANT TO THE TO THE ENTIRE FINANCING ECOSYSTEM. IT’S PARTICULARLY IMPORTANT FOR US AS A TRI-PARTY AGENT BECAUSE IT CREATES A NETWORK EFFECT FOR OUR CLIENTS.

particularly are working towards complex metrics and that might include, types of counterparties and specific types of collateral, depending on their binding constraint.

That may be LCR, NSFR or certain Risk Weighted counterparties. Lenders are in a similar position, particularly when indemnification is involved as an example. So that’s really where counterparty diversification becomes important. I think it’s becoming more important moving through to 2024. In the rising rate environment, we’re starting to see clients lose that access to cheap funding that they’ve had in the past. They will no doubt be starting to look towards the secured funding markets to take some of the capacity they require.

EH: From your perspective, are we seeing a lot more entrants to the market in Asia?

WJ: Asia continues to be an exciting place. It wasn’t that long ago that the Asian triparty financing space, [and that’s specifically from a tri-party financing perspective] was predominantly the global investment banks utilising APAC collateral with the major global agent lenders, and it wasn’t uncommon for people to question where all the APAC counterparties were.

We are certainly starting to see a shift there now with more, internationalisation as new regional counterparties explore the benefits of tri-party. That’s not to say that there haven’t been local counterparties active in Asia, because there always has been, only they’ve been focused on their local markets. From a collateral perspective, that’s been concentrated on local cash and local securities from a bilateral perspective specific to their market.

New regional counterparties are really starting to realise the benefits of triparty. Triparty provides a powerful tool that allows them to further grow and scale their business, and that’s in several different ways. That’s realising automation and operational efficiencies, which is at the heart and the basics of tri-party, accessing and trading with a new network of cross-border counterparties, utilising and accepting a broader range of securities despite time zone challenges

and finally, the widening of collateral schedules - this is a key thing that we’re seeing in Asia where there might be wrong way risk that’s inherent in some of the local markets, but it also gives lenders the opportunity to search for further yield opportunities. Meanwhile, global borrowers can access new supply of securities and new liquidity, and global lenders can open new distribution channels of demand.

So, a final prediction for 2024 is that we’ll continue to see new counterparties into the tri-party financing space, but it’s also worth mentioning that this trend isn’t just specific to Asia. It’s something that we’re seeing across all three regions that we support [US, EMEA, APAC].

EH: That’s interesting. Finadium had some stats that I saw recently where they estimate the amount of assets in tri-party [across all tri-party agents] is about 6 trillion and it went from 4 to 6 trillion in the last two years. But if you look further back, it took about seven years to go from 2 to 4 trillion. So, the rate of increase in adoption is quite exponential.

WJ: We are starting to run out of time. However, I have one more question for you that I’d like to ask, and it’s on the topic of tokenisation, something that we’ve been hearing and reading a lot about. Obviously, J.P. Morgan is very active in expanding this space, but when I look at this survey that we sent to clients, it’s scored quite lowly in terms of client priorities for next year.

What are your thoughts about this?

EH: Great question. I think it’s fair to say that I’m probably more bullish on tokenisation than some other people, and maybe that’s because I’m not at the coal face of having to actually integrate it, but I spoke on a panel at ISLA in June and the title of the panel was “It’s All About Collateral”, and there was a combination of sell side and buy side there where I, out of all the people on the panel was the most bullish.

So why am I bullish? Because there’s so many use cases and I could spend hours and hours talking about it, but if I talk about the use cases I find the most exciting. Firstly, it’s

around tokenising for the purposes of margin which is very powerful. If you look especially in the clearing landscape where as I mentioned earlier, transfer of margin is not the most efficient, whether it be for the CCPs, intraday margin calls to the clearing brokers or whether it’s clients who have to pre-fund margin to the clearing houses in Europe to be able to trade, tokenisation could simplify and improve the operational process so well.

Secondly, tokenisation brings new assets into the funding landscape that weren’t traditionally easy to access. Case in point, money market funds, and that’s something that we did as a use case on last year and showed that you can transfer money market funds as collateral and then I think the third thing with tokenisation, of course, is that it reduces gap risk or credit risk.

If you look at what HQLAx is doing, where they’re working towards delivery versus delivery. Tokenisation mitigates risks in these typical crossborder trades that you have of treasuries versus JGBs. So to me, why wouldn’t everyone want to embrace this? Now, in reality, of course, there’s no market consensus on what type of blockchain to use, and ultimately investment budgets are constrained.

Everyone is trying to figure out if there is a benefit to being a first mover, or which horse they should back. So, I get it. There are many competing priorities, but I really hope when we rewatch this video in a year’s time that my prediction that tokenisation will have outperformed people’s expectations will hopefully come to pass.

WJ: Yeah, I think the benefits are undeniable, we certainly see that, and I think there’s a lot more development to come.

Well, thank you Eileen. It’s been fun to chat with you through what we see as the trends for 2024. Optimisation remains a key theme and something that our clients will continue to expand on.

So thank you very much for your time. And to our listeners, we hope you found these topics interesting.

AL: Thank you very much for listening and I hope you enjoyed the conversation

Eileen is the global head of trading services sales within J.P. Morgan’s Securities Services business. Eileen began her career in interest rate sales in 2003 and moved thereafter to interest rates exotics trading, both at J.P. Morgan and at Morgan Stanley.

She joined J.P. Morgan’s derivatives clearing business in 2011, initially to build out the rates OTC client clearing franchise. Her product and market responsibilities expanded thereafter, culminating in her leading EMEA derivatives clearing sales from 2016. In May 2022, she moved to her current role, with global sales responsibility for the trading services business, which encompasses agent securities finance, collateral management and tri-party.

Eileen has a first-class degree in natural sciences and management studies from the University of Cambridge.

Will leads J.P. Morgan Sell Side Trading Services sales in Asia and is responsible for developing and maintaining relationships with banks and broker dealers within region. Prior to J.P. Morgan, Will spent seven years at BNY Mellon where he held various roles across Sydney and Hong Kong, most recently as APAC Head of Sales and Relationship Management for BNY Mellon Clearance and collateral management.

Will holds a Bachelor of Business from the University of Technology, Sydney and a Post Graduate Diploma in Applied Finance (financial markets) from Kaplan Australia.

Will Jeffries, executive director head of sell side trading services sales, APAC

Eileen Herlihy, managing director global head of trading services sales

CCPs: better management or harder work?

Regulators remain keen to push volumes towards central clearing to justify the original purpose of maintaining systemic stability. This process has seen the scope and number of CCPs continue to grow: most recently, in the US, DTCC’s Fixed Income Clearing Corporation (FICC) has proposed extending mandatory clearing beyond businessto-business to include business-to-consumer applications.

“To lower systemic risk, regulators are making the use of central counterparties more appealing

through various mechanisms,” says Todd Crowther, head of corporate development and collateral services, Pirum. “As well as the benefits, the use of CCPs increases the volume of margin calls. This places more demands on legacy systems which typically were not developed to support these use cases.”

As pressure increases to use them, participants have become increasingly familiar with the pros and cons of CCPs.

They reduce counterparty and credit risks; for

As their use grows, participants have become more familiar with the pros and cons of CCPs, and the cost-benefit calculation underlying the decision to use one has become more nuanced.

securities financing transactions, this means that stock borrowers and lenders, as well as repo and reverse repo counterparts can benefit from lower capital costs and better risk-adjusted returns, in some cases.

Buy side firms vary considerably in how prepared they were for the latest UMR phases. Those that are small, lack resources, and are less knowledgeable on connectivity scrambled open custody accounts in time. Others that could, sought to delay the changes by seeking to defer.

For many, the additional stability, standardisation and risk mitigation provided by CCPs is providing a good fit for the trading model. To those coming into scope from phases five and six of UMR, CCPs, though costly, may end up cheaper than managing non-cleared OTC trades themselves.

CCPs provide a single, appropriately capitalised counterparty which consolidates and nets exposures for those products that are cleared in the same venue. And, participants get greater control over their clearing activity, reassurance around risk and, increasingly, a range of options beyond traditional sponsored products.

Sell side participants are similarly drawn to the benefits when it comes to financial performance.

“CCPs mean RWA and capital costs are lowered in line with a reduction in counterparty risk. Market participants are able to increase trading volumes and extend trading more efficiently to lower-rated counterparties,” says Crowther.

But these benefits mean giving up the flexibility provided by an uncleared bilateral route.

“The historical demand to be CCP participants, has increased with growing capital constraints,” says Eric Stovicek, Americas sell-side trading services sales, J.P. Morgan. “But this is offset by the operational and technological challenge required to connect with several different CCPs.”

Flexibility around schedules is valuable when it

comes to growing ESG requirements. “Here, the principles are the same as any other schedule: you need to see the exposure intra-day. As well as what collateral is allocated, you must be able to screen collateral on-demand and pledge or accept and deliver the right collateral to meet increasingly tighter deadlines,” says Crowther.

“You can’t do it manually anymore and you can’t do it overnight, especially as we move to T+1 settlement. And you don’t want to end up accepting what is not permitted. So, that means going from a more manual to a fully automated operating model,” he adds.

The minimum requirement is to exclude assets that do not comply with collateral takers’ core ESG requirements from the collateral pool, says Benoit Uhlen, global head of MFS relationship management, securities services at BNP Paribas. Beyond that, the situation is evolving: “Institutions have their own requirements and views on ESG, therefore the approach is not yet harmonised, which makes it difficult for service providers to propose adequate services. For solutions to be efficient, market participants and service providers will need to agree on general ESG standards.”

Fragmentation

This growth of CCPs presents participants with many of the challenges posed by the widening scope of UMR: with more instruments covered and more places to clear, there are more venues to place collateral, and requirements around how it is posted, expanding the challenges when it comes to connectivity.

“You have more products that need to be delivered to more locations – in many cases, by leveraging differing operational and technical requirements. Then there is the question of the proliferation of collateral venues and more CCPs, including SFT-focused ones like TCN in Canada, CBOE in Europe and those, such as NSCC, introducing a non-cash collateral acceptance to increase balances,” says Crowther.

“The growth of CCPs and venues to place collateral is similar to bilaterally settling more buy and sell trades, namely delivering securities to hundreds of counterparties with the risk of fails,” says Stovicek. “Only, with CCPs it is worse, because if you can’t deliver the specific ISIN/CUSIP sold, you must meet the CCP’s eligibility criteria.”

These criteria, of course, vary from one CCP to the next, and are subject to change. “In this case, you need a retool of either manual processes, or the

THE HISTORICAL DEMAND TO BE CCP PARTICIPANTS, HAS INCREASED WITH GROWING CAPITAL CONSTRAINTS

Eric Stovicek, Americas sell-side trading services sales, J.P. Morgan.

internal process of automation you have built,” says Stovicek.

So, in many cases, growing use of CCPs works as an impediment to increasing automation, frustrating the wider journey towards more integrated, optimised, collateral management at a firm-level.

Deciding simply to deliver the always-eligible US Treasuries may well be at odds with efforts to optimise HQLA and minimising the cost of capital, for example.

“Any time a venue for collateral is added operational, complexity increases,” says Ted Leveroni, global head of margin services, BNY Mellon.

“Firms need to weigh the cost in terms of operational connectivity and fragmented liquidity, against the benefits of utilising additional venues. Further, firms need to be cognisant not to create additional siloes resulting in inefficient operations and liquidity bottlenecks. This trend has created opportunities for firms like BNY Mellon and others who provide automated holistic collateral and liquidity management across multiple venues,” he says.

“And, in practice, central clearing means FCMs/ dealers having many manual procedures, always with less-than-optimal use of collateral, and managing both incoming margin collateral from dozens of hedge fund and other clients, and onward delivering to each CCP,” says Stovicek.

For buy side firms, meanwhile, unless a CCP can support every derivative traded, they will have to build a solution for UMR. “Here, buy side firms can engage industry agents/vendors that support both margin pledge models, and can support many other tools from an integrated vendor,” says Stovicek.

He points to forecasting, feeds to and from industry utilities, optimal allocations, automated swap valuations and dispute resolution. “Then ultimately you could end up with partial or full back-office outsourcing to a third party to manage the whole process,” he says.

CCPs: measuring optimisation

Another area in which effective optimisation has become more complicated is around the question of how to measure the cost of cleared versus uncleared trades.

From a pure optimisation standpoint, the goal of breaking down silos and combining as wide as possible a range of instruments and asset classes must include cleared transactions. But resources are limited, and a degree of prioritisation is typically needed.

Pre-optimisation is a stage that merits meticulous analysis. Like trade analytics, pre-trade analytics should be able to deliver meaningful benefits by making use of collateral projections and an effective optimisation algorithm.

Ideally, a solution should provide the means to effectively mobilise collateral on a forward-looking basis. This means joining up the views of exposures

[FOR ESG] THE PRINCIPLES ARE THE SAME AS ANY OTHER SCHEDULE: YOU NEED TO SEE THE EXPOSURE INTRA-DAY

Todd Crowther, head of corporate development and collateral services, Pirum.

at multiple CCPs, as part of an approach achieving cross-venue optimisation of collateral where and when it is most needed.

When it comes to price, meanwhile, the maths is more complex just picking the clearing venues that are cheapest. Some counterparties may prefer certain routes, meaning intangible wider benefits in terms of improving the client relationship.

In repo and securities lending, there is a high concentration of volumes and activities amongst a small number of participants. They are usually well capitalised and rated, meaning, for these transactions, clients are less willing to push trades into CCPs, says Uhlen. “However, regulators are increasingly pushing for this model as it provides them with transparency and therefore oversight of these transactions,” he notes.

Stovicek says it is hard for an optimisation algorithm to consider all, or even most, of a firm’s internal requirements of this type. Many are not standard across the industry or easily drawn from public information.

This adds an extra dimension to the choice between employing a triparty agent’s algorithm, one from a third-party vendor, or building one internally. The calculations – spanning cost, resource commitment and time-to-live – quickly become complex.

“And this decision only relates to the optimisation algorithm,” Stovicek notes. “In fact, there are several other decisions that need to be integrated into the process, including tech builds or buys to achieve operational efficiency and going live soon enough to realise the benefits before the industry paradigm shifts again,” he says.

Ledger tech

Digital ledger technology (DLT) could yet provide a rival channel to both central clearing and conventional bilateral uncleared trades. It promises the prospect of optimising inventory as efficiently as possible, whilst ensuring control over costs, and reducing the drain on intraday liquidity created by buffer payments required by CCPs.

Applying the blockchain means positions can be synchronised instantaneously, eliminating intra-day credit exposure.

This will transform cases where margin is currently required for delivery-versus-payment trades. In this case, where a buyer’s cash payment must be made prior to or at the same time as the delivery of the security, the custodian needs margin to borrow the P-leg while the other side settles.

In free-of-payment trades, the customer loses liquidity as soon as the payment is sent, since the CCP needs to cover its losses in the case of default. Here, too, DLT promises huge benefits.

Averting a liquidity crunch?

The potential impact for clients is visible when you consider how last September’s LDI pension gilt crisis in the UK might have been averted by processes based on DLT.

Here, the speed of swings in bond prices triggered multiple intra-day margin calls and a rush to sell assets to provide cash to cover fast-depreciating value of positions – with participants selling gilts to cover losses on gilts, accelerating the problem.

At the heart of the problem were the delays in moving non-cash collateral: without these, the need to raise cash through forced sales disappears. But an effective DLT solution allows to post non-cash as quickly as cash since participants don’t have to physically post their bonds.

“Participants use cash for variation margin since it is operationally easier and all counterparties are happy to accept it,” says Charlie Amesbury of HQLA X. “The ultimate plan is to make non-cash as easy and operationally friendly as cash, so participants don’t need forced sales to meet margin requirements.”

INSTITUTIONS HAVE THEIR OWN REQUIREMENTS AND VIEWS ON ESG, THEREFORE THE APPROACH IS NOT YET HARMONISED

Benoit Uhlen, global head of MFS relationship management, securities services at BNP Paribas.

PARTICIPANTS USE CASH FOR VARIATION MARGIN SINCE IT IS OPERATIONALLY EASIER AND ALL COUNTERPARTIES ARE HAPPY TO ACCEPT IT

Charlie Amesbury, institutional sales, HQLAX

Collateral schedules: the cornerstone of the evolving collateral landscape

Global Investor speaks to BNP Paribas’ Xavier Jacobée, co-head of triparty collateral services, securities services, and Matthieu Leredde, product manager for triparty collateral services, securities services, on their approach to address clients’ needs around collateral schedules, leveraging technology and data analytics.

Could you briefly remind us of what collateral schedules are?

Collateral eligibility schedules are discussed and agreed between counterparties during deal negotiation (repo, securities lending or OTC derivative transactions for example).

They describe in detail the assets which are accepted as collateral by the receiver and can be composed of many rules, which are set-up within the collateral managers’ platforms.

Eligibility schedules encompass rules for asset eligibility (e.g. only Government Bonds with an investment grade above BBB), as well as concentration limits (to ensure the diversification of the collateral), and haircuts to be applied on the value of the collateral.

Which challenges do financial institutions face in managing collateral schedules, and how does BNP Paribas handle these challenges?

Challenges for financial institutions arise throughout the lifecycle of a transaction.

During the trade negotiation, the agreement of the eligibility terms between participants is often done through a cumbersome paper-based process, and needs to take into account the collateral managers’ capacity and internal risk policies.

Once the schedules are approved, the eligibility rules must be implemented and represented within different systems (e.g. triparty platforms), a task which can be complex and lengthy. Additionally, there is a risk for those terms to be wrongly

IT CAN BE DIFFICULT FOR COUNTERPARTIES TO EFFICIENTLY MANAGE COLLATERAL ALLOCATION AND OPTIMISATION AS THE INFORMATION AROUND ELIGIBILITY AND COLLATERAL POOLS IS NOT ALWAYS EASILY ACCESSIBLE.

interpreted or set-up, which can impact the quality of the collateral received vs. requirements.

Then throughout the transaction lifecycle, it can be difficult for counterparties to efficiently manage collateral allocation and optimisation as the information around eligibility and collateral pools is not always easily accessible. This is mostly due to:

• Complexity to dynamically reflect evolving schedules from third parties, especially considering that numerous rules can be expressed differently depending on the system (triparty platforms, clients’ optimisation engines, vendors’ platforms…)

• Challenges to build a comprehensive and realtime view of all positions and movements, as assets and collateral pools are scattered across multiple venues.

We also observe a lack of flexibility to easily update eligibility conditions to follow the evolution of transaction terms or internal policies.

In light of these issues, we see the rise of new clients’ requirements:

• There is a growing user appetite to negotiate eligibility terms online, through a fast and simplified process.

• Sell-side clients require a holistic and granular view of their collateral activities as they leverage in-house tools or third-party vendors to make the best use of their assets.

• Collateral givers and receivers have growing expectations to access extended simulation capabilities or analytics, supporting decisionmaking.

To answer these requirements, the Securities Services business of BNP Paribas has invested in a mid/long-term plan to co-design with clients, solutions to digitise the management of collateral schedules and associate value-added services.

To this end, our modern triparty collateral platform, jointly with the latest technologies, offers the agility required to support the bespoke features expected by clients.

How can technology and data analytics enhance the efficiency of collateral schedules management?

Data is the fuel of collateral engines. Every single eligibility rule ultimately entails the observation and computation of multiple metrics and market data. To satisfy evolving clients’ requirements, all actors must not simply integrate data to check eligibility but must now go beyond and provide additional support through portfolio analysis and optimisation of asset allocation.

One long-standing concern has been around the technical ability of legacy platforms to treat the ever-growing amount of data – which is massive –a challenge that has been overcome by the more scalable cloud-based platforms, such as the one we use at BNP Paribas.

In parallel, Application Programming Interfaces (APIs) are simplifying the information flows between counterparties’ and third parties’ systems, further accelerating data processing, and improving time-bound relevancy.

Coupled with Artificial Intelligence, this is progressively expanding the automation scope to unstructured data which are typically part of complex documents (e.g. legacy collateral schedules) or emails and chats.

Deep learning, another type of AI, is now also offering new possibilities around predictive analysis and proactive investigations (e.g. to anticipate settlement fails or future collateral requirements).

These technologies are as such opening a wide spectrum of advanced services for counterparties, including real-time collateral simulation, inventory usage efficiency, suggested eligibility updates, or even identification of new trading opportunities.

Many other concrete evolutions of collateral practices remain ahead of us as mature use cases start to unfold for technologies like distributed

REGULATIONS AND MARKET PRACTICES LED TO A MASSIVE ACCELERATION OF THE NEED FOR COLLATERAL, A RESOURCE WHICH WHICH CONTINUES TO BE SCARCER AND SCARCER.

ledger technologies and generative AI. All in all, technology and data are key to improving collateral management, and more specifically collateral schedules management.

What opportunities does BNP Paribas foresee in optimising collateral usage and generating additional value for clients in the evolving market?

Regulations and market practices led to a massive acceleration of the need for collateral, a resource which continues to be scarcer and scarcer. The size of the triparty collateral market has almost doubled over the past eight years, now reaching around € 8.5 trillion (£7.27 trillion). Collateral management is therefore becoming a central cross-asset function, supported by robust engines.

In this context, our clients do not see us as a simple utility to transfer eligible collateral anymore, but rather as a true partner to help them make the best use of their assets and find new sources of funding.

We notably see our bank clients increasingly leveraging our ability to source their collateral directly on their domestic accounts, defining custom rules for assets selection and priorities between their different source accounts. This allows clients to broaden the scope of available collateral, to minimise collateral shortfalls and to avoid complex and costly asset rebalancing between domestic markets and the so-called triparty “longbox”.

With this continuous ambition to simplify the usage of our services, we have also extended our connectivity with additional third-party vendors and fintechs, in order to rationalise the number of interfaces that our clients have to manage and in order to help them to mobilise their collateral more efficiently across venues.

Our APIs have also allowed our clients to connect their front-office engines directly to our platform and especially to our simulation module. With this connector, they can now benefit from real-time eligibility checks and what-if scenarios to anticipate their collateral allocation and free other assets.

ESG policies is another area where improved market data and collateral matrices can play an important role. All actors, including triparty collateral agents, are increasingly required to

OUR APIs HAVE ALSO ALLOWED OUR CLIENTS TO CONNECT THEIR FRONT-OFFICE ENGINES DIRECTLY TO OUR PLATFORM AND ESPECIALLY TO OUR SIMULATION MODULE.

offer and leverage a granular set of ESG-driven data and analytics, as well as offering flexibility to update collateral terms to take ESG policies into account.

How does BNP Paribas leverage its collateral scheduling services to ensure effective collaboration with clients to align with their risk management objectives or regulatory requirements?

If we take UMR as an example, we have supported a wide range of firms that need to comply with regulatory initial margin obligations. The challenges brought by this new set of obligations are well documented. However, when it comes to collateral eligibility, brand new actors were introduced to the triparty ecosystem, actors that had to be properly accompanied – including their risk team – to ensure their compliance and risk policies were meticulously respected.

Across all collateral use cases, we continue to enrich our toolbox in order to allow clients to have flexibility when it comes to reflecting their own risk management policies and control their application at any time. We are also ensuring we are prepared for any regulatory or market events. In the current economic and geopolitical context, clients’ risk policies (and by extension clients’ collateral schedules) are adjusted frequently. As a collateral manager, we must ensure we can quickly turn around hundreds of requests to update collateral rules.

Finally, and importantly, we continue to support the work engaged by European central banks and industry associations to reach a greater level of standardisation in collateral management practices and eligibility taxonomy. Our agility will be key to continue to stay close to individual and bespoke client needs, while aiming to reach an effective level of harmonisation across the industry.

Redefining collateral mobility

Collateral management should no longer be reviewed only as an operational pain point, but as a strategic differentiator for those that do it well!

Over €24 trillion (£20.6 trillion) of securities were allocated to collateralise securities lending, repo and margin obligations at the end of 2022. Whilst the size of the market is staggering, traditional collateral management methods to manage collateral across a fragmented global custody network can create significant inefficiencies and pain-points for market participants. Clients need to access and allocate collateral between counterparts, from different custody locations, between triparty agents and custodians. The inherent fragmentation of securities settlement system infrastructure and the inefficient collateral management mechanisms linked to it can cost a Tier-1 participant up to €50-100 million per year.

Cross-custody movements of inventory often consume precious intraday liquidity and can create costly intraday credit (RWA) exposures. The inability to move assets in an agile, real-time way

of the Market

often results in sub-optimal allocation of cheapest to deliver assets, which means market participants are leaving money on the table. Furthermore, collateral immobility related to cut-off times leads market participants to carry excess collateral buffers (buffers on top of buffers), which create a significant drag on bottom line profitability. Lastly, cross-custody movements of securities are also subject to costly settlement fails risk.

Turning a problem into an opportunity

Our goal at HQLAx is to eradicate these inefficiencies and significantly reduce our clients’ costs. By dramatically improving collateral mobility, we are enabling our clients to optimise their collateral management, improve liquidity, reduce risk and to have greater certainty and control. Our platform enables ownership of collateral to be transferred without having to move the

Source: Finadium

Europe Repo US Repo Asia Repo Securities Lending OTC Derivatives (Bilateral) CCP's (All products)

Figure 1: Size of the market

underlying collateral from one custodian to another. Ownership of securities is transferred whilst the securities themselves remain static, in their current custody location. This allows for ownership transfers of securities to happen in real-time and enables our clients to satisfy their collateral obligations with much greater precision.

A trusted third party uses the HQLAx ledger as its golden source of truth for ownership of securities under its custody. A client’s banking operations teams simply instruct the on-ramping of inventory onto the HQLAx ledger. To meet collateral obligations, the ownership of that inventory can be transferred and registered, all within the HQLAx ledger. There is no physical movement of the securities. The HQLAx ledger is updated to effect legal title transfer of securities whilst the underlying securities remain with preferred custodians.

Covering the Market

On the pathway to redefining collateral mobility, HQLAx is expanding its product suite to service the complete range of collateral obligations across securities lending, repo, and margining. As we look back to figure 1, our live products cater for the

Without HQLAX

Collateral optimization within silos

Cross-custodian movements

Only by end-of-day

Only when custodians are open

No Delivery vs Delivery (DvD)

With settlement risk

Consumes costly intra-day liquidity

securities lending market, which makes up 10% or €2.4 trillion of assets held for collateral obligations. As such, we are expanding our product set to cater for as large share of €24 trillion market as possible, and the addition of DvP repo and margin management capabilities are central to that.

We are particularly excited to see the progress of a number of projects that have been going on in the background in the DvP repo space as we work on a scalable ‘plug and play’ orchestration process across multiple solutions. HQLAx does not have cash on ledger, so we have been working to ensure our digitised collateral is compatible to exchange versus both fiat and digital equivalent currencies. In the digital cash space in particular, we have been working alongside market leading providers in Fnality and Onyx by J.P. Morgan and are targeting the execution of a DvP repo by the end of this year. Not only does this bring a new product segment to market, it has also been an invaluable process to ensure our platform is interoperable with other digital ledgers and solutions providers in order to be able to service the market participants with whomever they choose to partner with.

With HQLAX

Collateral optimization across silos

Reduced cross-custodian movements

At precise moments in time (real-time)

When you want (outside custodian cut-off times)

With DvD

Reduced settlement risk

Reduced intra-day liquidity consumption

Figure 2: Benefits of HQLAX

How it works: DvP Repo

1. The cash provider and cash taker agree the DvP repo in the marketplace layer which communicates the transaction to HQLAx

2. The cash provider ensures that sufficient cash is positioned on the digital cash ledger and the cash taker positions sufficient eligible collateral on HQLAx to effect the settlement of the trade.

3. When the value time is reached, the DvP repo is settled atomically as a result of the ownership of a Digital Collateral Record (DCR) and the respective digital cash balance being updated across both platforms. The swap is only completed when both ledgers confirm that all criteria have been fulfilled.

4. Ensuring that each ledger’s boundaries are respected, no collateral is represented on the digital cash ledger and no cash is represented on HQLAx

This product not only allows the ability to trade repo intra-day or term at precise moments in time, it also improves the mobility and liquidity of collateral giving the facility to settle transactions across regions, regardless of market opening hours. This will enhance resilience, reduce risks, and reduce the problem of fragmented liquidity.

Moving onto our margin management tools for both OTC and CCP derivative exposures, we have been working alongside market incumbents to enhance margining options compared to solutions offered today. We can take the operational headache away from allocating ISINs to cover margin calls, allow for automated substitution and pave the way for real-time margining.

How it works: Margin Management

1. The client moves securities to the HQLAx platform where they are linked to a Digital Collateral Record (DCR) at the ISIN level.

2. The ISIN DCR can then be transferred to another participant to fulfill a VM requirement at any time.

3. HQLAx confirms the transfer of ownership instantaneously.

This will make collateral settlement seamless with on-ledger transfer accelerating the collateral mobility between long boxes. It will mitigate the operational backlog that occurs for margin processing for non-cash collateral and therefore reduce risk and

regulatory exposure. Simply put, the aim is to make allocating non-cash collateral in the form of DCRs as easy and as fast as allocating cash, thereby increasing utilisation of collateral while decreasing the use of more costly cash.

Through offering DvD, DvP and margin management products, whilst considering the underlying work of connecting with current market infrastructure players and other digital ledgers, HQLAx is creating a fully interoperable platform, the platform to digitise collateral.

Frictionless, precise and real-time transfer of ownership of securities

The benefits of using DLT in the collateral management space are clear. Clients can increase the mobility of assets that have previously been trapped in custody or triparty siloes, are able to mobilise assets that have been hard to fund through traditional settlement chains and benefit from reduced operational processing timeframes. As clients continue their journey into the DLT world, they need to be able to process transactions between the two ecosystems during the transition period, to integrate both the existing pools of collateral and the assets that are on-ramped to a ledger. Integrating the HQLAx platform with a client’s optimisation engine can help with this and further maximise collateral optimisation across both collateral obligations and all custodians / triparty agents. The Optimisation Engine can view both the on ledger and off ledger collateral along with the obligation and can therefore determine the optimal allocation of those assets.

A great starting point is to analyse your banks existing collateral footprint and annual costs for cross-custody movements of inventory to understand the bottom-line benefits of using solutions such as HQLAx and to move towards a more frictionless, precise, and real-time collateral management.

Author Biography

Charlie Amesbury

Part of the HQLAx sales team who is focused on driving sales from the London office. Previously, worked at Morgan Stanley for a number of years in their Prime Brokerage department, covering hedge fund clients.