Chief operating officers at global asset management firms are increasingly looking to outsource some of their collateral management to third-party service providers to meet post-crisis regulatory change.
In Asia, regulators and exchanges in Hong Kong, Japan and Singapore have endorsed the G20 commitment made in September 2009 requiring mandatory clearing of standardised OTC derivatives through a central counterparty (CCP).
For OTC contracts that cannot be cleared by a CCP, meanwhile, bodies such as the International Organisation of Securities Commissions (Iosco) and Committee on Payment and Settlement Systems (CPSS) have been leading global initiatives to issue standards for financial institutions to post collateral to reduce counterparty credit risk related to these OTC trades.
The Hong Kong Monetary Authority and the Securities and Futures Commission, for instance, announced their intention to follow such margining requirements in their joint-consultation on the future OTC regulatory regime, which closed in November last year.
Meanwhile, under the Dodd-Frank Act, US banks trading OTC swaps with asset owners such as Asian central banks and sovereign wealth funds would also likely be subject to such clearing requirements, due to the extra-territorial implications of how the Dodd-Frank Act will apply.
These regulatory changes are being implemented gradually over the next two years. And Rafael Lopez, Pimco’s head of operations for Asia-Pacific, says that due to the firm's fiduciary duty to clients, it is committed to ensuring all transactions are appropriately collateralised.
“Such processes must be done in-house and that must be managed and coordinated across functions at the front-end, such as the trading and cash desk, and by the collateral team,” he says.
However, where the service providers come in (Pimco has outsourced many of its back-office functions to State Street) is that they can help asset managers to develop their accounting, asset warehousing and reconciliation systems to be able to handle functions such as haircuts applied to various types of collateral, and aggregation across different products.
COOs at other asset management firms agree that collateral management is increasingly high on their agenda.
If an asset management firm uses a non-deliverable forward contract, for example -- which the Singapore Exchange has started offering clearing services on -- then the AM firm’s back-office and collateral management team would need to post margin on a day-to-day basis, something that traditional long-only funds are not usually accustomed to doing.
Swaminathan Balasubramanian, regional COO for Eastspring Investments' funds business, says regulation around clearing is making collateral management a key part of its business.
“While collateral issues can be managed in-house, you should do a cost-benefit analysis: what are your volumes versus the size of the investment you’ll need to make. Many custodians and other providers are coming up with collateral solutions and we’d look to outsource this,” he says, adding that complexity will increase around daily marking to market.
On the service provider side, players are eyeing opportunities in collateral management as the need to focus on reducing counterparty risk -- and a generally heavier focus on investor protection after sagas such as the minibonds scandal -- have led securities regulators to impose stricter rules on the need to collateralise complex products.
Last year the SFC required asset managers providing synthetic ETFs, such as Hong Kong-listed A-share ETFs, to fully collateralise the counterparty risk exposure faced by investors, making use of derivatives instead of physical cash equities as a key construct of the ETF.
Previously asset managers were allowed to leave un-collateralised counterparty risk exposure to 10% of the fund’s net asset value.
A banking source at Citi confirms he has seen increased demand for collateral management services since this new rule was brought in as asset managers seek to top up the collateral backing synthetic ETFs.