Meeting the margin challenge
Clearing Houses collecting margin to manage their counterparty risks is perhaps the central tenet of the G-20 plan to de-risk the derivatives market. To work, it depends on collateral moving quickly and efficiently between market participants and clearing houses. Time is tight and delays can have major consequences.
COO, DTCC Euroclear GlobalCollateral Ltd.
Today, market participants frequently struggle to move margin and collateral end-to-end and efficiently in cleared markets. Existing pipes and channels were not built for high volumes of time-critical margin calls, and yet that is the consequence of the new regulatory world.
CCPs, FCMs and the buy-side know they need to remove barriers to intra-day collateral movements. The whole industry must work together to eliminate high-risk, high-cost manual workflows and move beyond the limitations of batch processing. Utility-like solutions are a proven way of helping market participants deliver important and wide-scale industry change.
Real-time collateral access
For me, the importance of the challenge was reinforced at the 33rd Annual FIA Futures & Options Expo held in Chicago in October. On a panel discussing CCPs and liquidity risk, fellow-speakers highlighted the challenges for FCMs handling intra-day margin calls on behalf of clients. In turbulent market conditions, an FCM could receive an intra-day margin call from a CCP at short notice that needs to be covered almost immediately but have to wait until near close of business to receive collateral from a client. The end-to-end operational flows have not yet caught up with the realities of today’s market. What is required is the right type of pipes and plumbing that are specifically designed to satisfy intra-day margin calls.
In the context of the these timing mismatches, one central bank panellist raised parallels with Herstatt - the infamous German bank that, in 1974, defaulted at 4:30 p.m. European time exposing a structural timing flaw in Foreign Exchange markets. At the moment of default Herstatt had received Deutsche Marks from its US counterparties but had not yet completed the US Dollar leg of the settlement, leading to heavy losses.
Herstatt had enormous consequences, not least the creation of the Basel Committee on Banking Supervision and the implementation of Real Time Gross Settlement Systems (RTGS) for high value payments. However, it took much longer to get the pipes and plumbing in place to actually eliminate Herstatt risk in FX markets. That was only achieved in 2002 with the launch of CLS Bank.
As the aftermath of Herstatt showed, incremental process improvements by individual institutions are necessary, but insufficient to eliminate systemic risks. Fortunately, we have not had to wait almost 30 years to improve the pipes and plumbing for margin and collateral processing.
To meet the need to move margin and collateral seamlessly and efficiently in cleared and un-cleared markets, including intra-day margin settlement, Global Collateral has worked with market participants to develop its two utilities - the Collateral Management Utility (CMU) and the Margin Transit Utility (MTU). MTU has the real-time capability to support the straight-through processing of margin calls by FCMs and their buy-side clients and CMU to optimise and automate collateral management intra-day between FCMs and CCPs. This helps manage liquidity, reduce operational cost and risk and optimise allocation of collateral.
Global collateral optimisation
Mandatory clearing, collateralisation and reporting of derivatives trades all contribute to the monitoring and mitigation of risk. But often it is only by getting the right pipes and plumbing in place that markets are able to develop new levels of standardisation, transparency, speed and efficiency and address systemic risks.
Contact us for more information on IMS and GlobalCollateral services:
Joyce Thormann - Euroclear
Director, Sales and Relationship Management