Collateral, Margin and Dodd-Frank

Last month we saw the widely anticipated delay in deadlines for implementation of Dodd-Frank regulations.  This month the European Parliament took a similar step in delaying rules intended to improve transparency around OTC derivatives trading. As market participants examine the proposed regulations more closely, the associated operational challenges become more evident, and hence the push to delay compliance.

An area of current focus is that of collateral and margin.  Key questions abound regarding potential for co-margining across asset classes, and the resulting implications for collateral held.  It is also unclear whether positions for US customers will need to be margined on a gross basis, which would mean an FCM would have to post the same amount of initial margin as it collects from its client –not ideal from the broker’s perspective.  Added to this, is the data and operational practices for the newly cleared OTC contracts (interest rate swaps and credit default swaps), significantly different from that of standard futures and options. This results in further IT and operational costs and risks.

Compounding the uncertainty of how the rules will ultimately be finalized is the deluge of operational complexity the new rules will bring.  Many firms recognize this will also require structural overhaul, and are looking at the associated organizational and business process changes necessary to bridge existing business silos.  Teams may need to be restructured, and workflows revised.  According to a recently published report by the Tabb Group, technology solutions from third party software providers can significant help tackle these challenges.  One area where technology solutions can help is in the reconciliation and exception management of derivatives.

When it comes to reconciliation, advanced technology solutions can help firms to automate, normalize and enrich data that today comes from exchanges in all manner of disparate files and formats.   Then, complex rules can be applied to parse business attributes for initial margin, variation margin, cash, positions, trades and fees reconciliations.  Logic can also be efficiently applied to deal with other business complexities associated with derivatives, like exercise/assignments, average price trades and position transfers in order to achieve high match rates, and further improve operational efficiency.  Ultimately, when broker-dealers are able to reconcile and manage exceptions faster and more easily, they can enable better business decisions. 

While many market participants are focused on the onerous nature of complying with extensive new regulations, it’s worth noting that there will be real operational and strategic advantages to optimizing these manual processes.   Beyond appeasing the regulators by improving accuracy and auditability, investing in improvements to these manual processes will actually allow savvy broker-dealers to gain a competitive edge.  With increased transparency and efficiency, firms can better enable more sophisticated strategies such as risk based margining, cross margining, rehypothecation and netting and gain greater visibility to liquidity.  Without real-time visibility and transparency to the business, those strategies simply can’t be leveraged.