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GlobalCollateral’s Inventory Management Service

The post 2008 wave of financial regulation has impacted collateral management in two fundamental ways. Regulations now require financial institutions to post significant amounts of margin to collateralize previously unsecured exposures and, in order to comply with regulatory stress test, less liquid asset classes can no longer be funded on a short-term basis. These requirements coupled with the multi-year minimal interest rate environment and the constant drive to pursue operational efficiencies have created the need for banks to optimize their collateral on a global basis. However, this shift is not without significant operational challenges. Nowhere is this more apparent than between the United States and European settlement environments. With this in mind, DTCC-Euroclear Global Collateral Ltd now introduces the Inventory Management Service – an automated service designed to mobilize US assets in the international triparty collateral management environment of Euroclear.

 

Towards a Global Collateral Optimization Model

 

The term collateral optimization has been a watchword amongst the global banking community for several years.  Although it has differing meanings to different market participants, it generally refers to a global approach to collateral management driven by the goal of assigning the most beneficial or lowest cost collateral to every exposure across securities finance and margin postings regardless of that exposure’s location.  This optimization is often referred to as allocating the ‘cheapest to deliver’ collateral to each exposure.

 

But the goal of global collateral optimization has historically been hampered by multiple settlement systems and the collateral silos these create.  Although banks and their clients have negotiated collateral schedules which include both European and US assets, the lack of interoperability between the respective market infrastructures has frustrated participants’ efforts to take advantage of the move towards the globalization of the collateral market.  This lack of interoperability was one of the drivers that prompted Euroclear and DTCC to come together in September of 2014 to form DTCC-Euroclear Global Collateral Ltd (GlobalCollateral).  One major goal of GlobalCollateral is to provide a means to efficiently mobilize US securities into the international collateral markets.

 

Outline of the Inventory Management Service

 

Key to this initiative was the need to sort through the multiple regulatory structures of the European Union and the United States.  GlobalCollateral’s model, as will be explained below allows US assets to be ‘moved’ from DTC to Euroclear Bank for deployment on collateral management transactions via Euroclear Bank’s triparty collateral management service, and for these US assets to be ‘moved back’ from Euroclear Bank to DTC when required for settlement or corporate actions.

 

On the 16th of December 2016, the Securities and Exchange Commission approved Euroclear’s request to expand its exemptive order to include US equities.  With this approval, US banks are now able to reposition US equities from their DTC account to Euroclear Bank via GlobalCollateral’s IMS for use in triparty collateral management transactions, thereby significantly expanding the already broad range of assets that can be mobilized in Euroclear Bank’s triparty environment. Now for the first time, US dealers are able to deploy US equities as collateral on a book-entry basis between two market infrastructures located respectively in the United States and in Europe.

 

With this approval secured, Global Collateral is now rolling out its IMS. This service allows participants to automate the movement of US equities, corporate bonds and asset backed securities from their DTC account to Euroclear Bank where they can be financed with international clients or pledged to satisfy a broad range of margin requirements. This process will occur entirely on a book-entry basis within the core settlement structures of DTC and Euroclear Bank, and will also automate the recall and substitution processes typically required in collateralized transactions.

 

Operating Format

 

To take advantage of this service, a participant will open a new DTC sub-account linked to its main DTC account.  This sub-account, referred to as an IMS Sub Account will operate under the same debit cap as that participant’s main DTC account.  The participant selects the pool of securities it wishes to mobilize and repositions those securities from its main DTC account to its IMS Sub Account.  Once there, the securities are automatically moved to Euroclear Bank’s account in DTC and immediately reflected in the pool of collateral available within the participant’s Euroclear Bank account.

 

 

Securities repositioned into a participant’s Euroclear Bank account can either be managed as a separate pool of collateral or can be combined with other assets held in Euroclear Bank for triparty collateral management purposes.  In the event that a specific security position is required to be returned to a participant’s main DTC account to settle a sale, the participant initiates the recall process by entering a repositioning instruction from the DTC IMS Sub Account to their main DTC account.  This will trigger recall instructions along the collateral chain and automatically return the security to the client’s main DTC account.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Value

 

The IMS provides a tremendous step forward in the evolution of global collateral optimization.  By allowing US dealers or foreign dealers with substantial US securities franchises to reposition US assets into the international environment in an operationally and cost efficient manner, these dealers can broaden their funding base for non-liquid assets.  Accessing sufficient sources of long term funding to support trading in non-liquid asset classes has been a major concern for these institutions since the Basel III reforms announced the creation of the Liquidity Coverage Ratio.  In addition, US assets can now be mobilized to support the margin requirements of OTC derivatives and other exposures either with CCPs or on non-cleared transactions. With the introduction of the GlobalCollateral’s IMS, dealers can now consolidate assets across markets and asset classes and deploy those assets to satisfy any exposure around the globe.  With this innovation, financial institutions can now optimize across the two largest global market infrastructures servicing a combined $78 trillion in assets.

 

 

By Oscar Huettner

Managing Principal at LGM Financial Consulting