Collateralization increases in response to new regulations

The new requirements move more OTC derivatives into a cleared model

The economic crisis has ushered in a wave of global financial regulations, notably in the form of the 2010 Dodd-Frank Act and the European Market Infrastructure Regulation (EMIR).

A major goal of these new regulations is to lessen counterparty credit risk associated with over-the-counter (OTC) derivatives transactions by moving more of these derivatives to a cleared model and subjecting others to higher capital requirements. According to the International Swaps and Derivatives Organization’s (ISDA) 2012 Margin Survey, 84 percent of all 2012 transactions involved a collateral agreement, up from 80 percent in 2011, and large dealers delivered approximately $50 billion of collateral in central counterparties.

These trends are causing two main structural changes in the industry, according to Ted Leveroni, the executive director of derivatives strategy at Omgeo, which recently updated its automated collateral management software Protocoll in response to current and impending regulations. First, he predicts that the measures will result in “a significant increase in the number of collateral calls [firms] are going to have to process on a daily basis even with the same book of business,” estimating such calls could increase by between six- and eight-fold. Secondly, he says, the new rules will lead to a collateral shortage, requiring firms to better optimize their available resources.

These rules—many of which have not yet been finalized–have left some market participants scrambling to implement new systems. “It’s those two concerns: first, how do I work in this new environment? What’s needed of me?” Leveroni says, followed by “How do I thrive in this environment?”

The answer, Leveroni says, is transitioning from siloed operations to more streamlined, standardized systems that can manage both OTC and bilateral derivatives. “The first thing I think a firm should do is consolidate that operationally and technically, so you’ve got one group on one system that can manage all the collateral,” Leveroni says. “That allows the investment manager to manage their counterparty risk in an aggregated way.”

During the regulatory process, collaboration between market participants may ease the uncertainty about new requirements coming down the pipeline. “In the industry as a whole, I’ve never seen so much communication going on between independent participants—between vendors, consultants, any group within the industry…to just share ideas and knowledge,” Leveroni says.

 

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