Upcoming rules for bilateral clearing of OTC derivatives that will see a major increase in the number of collateral movements between market participants could see surging operational costs become "unsustainably burdensome", warns a new whitepaper.
If, when the new rules come into force in September, the current three per cent settlement fail rates for collateral movements prevail, operational cost will quickly become a huge problem, especially for buy-side firms, says the paper, from DTCC-Euroclear Global Collateral and PwC.
But the fail rate could actually increase, because the problems that cause them - miscommunication, constrained technology, insufficient collateral and counterparty insolvency - may be exacerbated by the complex changes that will be required to OTC derivatives workflows and documentation alongside increased margin call volumes.
The whitepaper suggests that by 2020, the average annual operational cost of remedying bilateral OTC derivatives collateral settlement fails for survey respondents could rise 407% to $3.6 million for each buy-side firm and 377% to $2.4 million for each sell-side firm. Meanwhile, the number of full time buy-side firm employees will increase from four in 2015 to 24 in 2020. Sell-side firms on average, are predicted to increase from three employees to 16.
Industry-wide unsupported exposure due to collateral settlement failure for sell-side firms alone is estimated to be $27 billion. When also factoring in buy-side participants the overall unsupported exposure "is likely to be much larger".
Mark Jennis, executive chairman, DTCC-Euroclear Global Collateral, says: "It is becoming increasingly important that firms assess and improve their current collateral and margin management processes, as regulatory obligations continue to increase. With current rate of collateral fails, combined with the expected increase in margin and collateral calls, firms must act now and ensure they can meet these impending challenges."