What Do You Mean by “Triparty”?
The increased complexity of margin rules governing derivatives trading is spurring growth in the use of segregated collateral account structures with custodians and triparty providers. Two such segregated structures are available: one arrangement includes both collateral selection and custody services and is widely used by dealers. The other, which can be called triparty or third-party, utilizes a third-party account control agreement with a custodian but does not incorporate collateral selection.
In an effort to minimize confusion, this article will call the first structure “triparty provider” and the second “third-party custodian.”
Whatever arrangement they choose, firms could greatly simplify their collateral management activities through use of a margin settlement utility that accommodates both triparty and third-party arrangements.
Triparty Provider versus Third-Party Custodian
The new rules taking effect in the derivatives markets pertain specifically to initial margin for derivatives. These regulations require counterparties to post collateral into segregated accounts at a third party custodian and some regulators have further required the segregated account be held at an unaffiliated custodian.
Some counterparties will manage this process bilaterally, that is, do their own work or use their collateral management administrator to select the securities in their accounts to be delivered. However, the complexity and resourcing required to manage collateral internally makes it attractive for many firms to outsource collateral management to a triparty provider.
Despite their similar names, the two models for collateral selection and segregation have distinct differences, particularly in the process by which collateral is moved between counterparties.
When counterparties use a triparty provider, first they agree to the required value of the collateral, known as Triparty Required Value or RQV, then the triparty provider selects the collateral to be moved and moves it from the giver’s account to a segregated account for the secured party. Under a typical derivatives contract, the secured party cannot access pledged collateral unless its counterparty defaults. Because eligible collateral is pre-determined by both counterparties, no ongoing day-to-day selection or affirmation is necessary. Examples of triparty collateral providers include JP Morgan, Bank of New York Mellon, Clearstream, Euroclear, and DTCC-Euroclear GlobalCollateral Ltd.’s (GlobalCollateral’s) Collateral Management Service (CMS).
In third-party arrangements, each counterparty establishes accounts at a custodian for margin segregation, and the collateral giver instructs the custodian to move collateral to the segregated account on behalf of their counterparty, the secured party. Counterparties must agree to the margin exposure and eligible collateral before a counterparty issues instructions to a custodian for movement of the collateral. Secured parties, and sometimes both counterparties depending on the documentation, must authorize the release or recall of excess collateral.
The route to consolidated reporting
No matter whether a counterparty uses the triparty provider or third-party custodian structure for initial margin segregation, it can streamline the settlement of uncleared swaps’ initial margin and variation margin through use of an industry utility like GlobalCollateral’s Margin Transit Utility (MTU). MTU is also able to consolidate collateral settlements and position reporting in one standardized format.
Triparty providers deliver optimized collateral management functions including collateral settlement, while MTU streamlines and consolidates the reporting—by sharing counterparties’ agreed-upon required value with the triparty provider and disseminating the provider’s post-settlement status updates to the counterparties.
For third-party custodian arrangements, MTU provides end-to-end messaging and reporting, from validation of the collateral message for processing to Standard Settlement Instruction (SSI) enrichment of the margin call and its formatting into settlement instructions. Post-settlement, MTU provides near-real-time settlement status notification to clients.
Through its ability to work seamlessly with bilateral margin calls without segregation as well as with third-party custodian and triparty provider arrangements, MTU can deliver operational efficiencies to the market by connecting all parties together in a single hub and facilitating operational efficiencies and collateral data transparency that can drive collateral optimization.