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Has Margin Call madness highlighted broader failures in the collateral ecosystem?

As Covid-19 sweeps the world we’ve seen global leaders in ICU, negative oil prices, record-high global debt, record-low interest rates, equity markets in free-fall, F1 teams building emergency medical equipment, and conspiracy theorists out in full force - no doubt there will be geopolitical powerplays going on behind the scenes. 5G towers and Chinese biochemical warfare, I’m not as convinced! And let’s not forget Brexit, the US election and where on earth is Putin?!

It is truly an uncertain world we are currently living in and this uncertainty is breeding voracious volatility, and where there is volatility there are, you guessed it, margin calls…a whole lot of margin calls!

Margin calls have sky-rocketed over the last few months, triggering prime brokers and banks to ask for more collateral from funds, investors and corporates to meet their exposure demands. With bond and stock funds becoming ever less valuable, the market is scrambling as their collateral fails to meet the grade.

This has resulted in defaults and an inability to meet margin calls, which could be a result of poor collateral management. For instance, one behemoth European bank took a $200 million loss when a single US hedge fund was highly leveraged, caught on the wrong side and inevitably unable to meet their collateral requirements, forcing the bank to close out for a gargantuan loss.

Collateral Management is an ancillary operation, one which supports the core activities of a financial institution, protecting the market and mitigating against losses. It is true that focusing on revenue generating operations can create your fortune but rest assured, neglecting your collateral operations can take it all away.

Vermeg (previously Lombard Risk) have seen significant increases in clients margin call volumes, both posting and receiving. Some of the largest financial institutions in the world have recorded 200% daily increases, fortunately none of Vermeg’s clients have reported any issue but others haven’t been so lucky.

Vermeg’s battle-tested collateral management system, Colline, is designed to support complexity, robustly and effortlessly handling thousands of margin calls between counterparties across all asset classes, with impressive 95% STP rates. This level of automation empowers margin managers to concentrate on the issues at hand rather than time-consuming manual processes and thus eases the burden on capacity and mitigates operational risk.

However, despite this, its effectiveness is not complete if the rest of the collateral ecosystem is less sophisticated, perhaps this is a wider industry issue? For instance, say that US hedge fund had better mechanisms for measuring their collateral exposure, the bank would not have taken such a loss.

The issue for firms who have invested in their operations, who can automate calls, statements, notifications, even installations and upgrades; is that its capabilities are blunted if the wider industry, and specifically their counterparties, have not made the same investment and still have paper-based functions, such as faxing custodians, or even manual excel functions.

Perhaps this is a question for the regulator, why are there still paper-based functions in 2020? Why is the industry so far behind modern technology? Gone are the days where you’d manually locate accounts armed with a Bic pen and highlighter’. We’re now in a world of electronic trading, automation, nanosecond executions, secure cloud hosting, and system consolidation of every asset class, every silo, every user and every trade. The need for investment and collaboration has never been higher.

Let’s take the analogy of a spider’s web or the world wide web. None of these are strong due to singular strands or connections, they are strong as a collective. And the same is true with digital networks and collateral ecosystems, if one defaults it doesn’t domino down the line, it is supported by the plexus of real-time, eligible collateral and ensures ‘the whole’ will always remain greater than ‘the hole’.

In reality, this looks like using Vermeg’s all-in-one Collateral Management Solution (Colline) with AcadiaSoft’s electronic messaging service, you can have a fully automated process from margin call being sent, agreed and booked – completely zero touch. A very efficient, accurate and unified process. This is without even touching on the bells and whistles of inventory management or collateral optimisation; it is just basic, efficient collateral management in 2020.

Collateral has historically been one of the least optimised functions within an operations team, hence struggles with higher margin calls but naturally giving it the biggest opportunity for improvement, or the 'quickest win' for operational investment. Regardless of when firms decide to invest in their collateral operations; the standards, automation and transparency will all one day be a regulatory requirement, transforming a fragmented ecosystem into a seamless one.

To learn more about what VERMEG and the Colline Team are doing, click here for more insights from our April Newsletter - including Colline in the Cloud, ETD Collateralisation, evolution of Tri-Party Connectivity and more.

07/05/2020

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