By Sue McGillion-Moore, Director (KPMG in the US)

The consequences of the market collapse of 2008 are still overshadowing the market today. Gone are the days when hedge funds or buy-side firms would rely heavily on their counterparts’ data for the aggregation, deployment, and settlement of their margin calls. Gone are the days of a single prime broker, where the re-hypothecation of assets was plentiful and profitable. The world is now a different place in the realm of collateral management. 

Buy-side firms have been progressively moving to a multi-prime broker model; this trend combined with the introduction of regulatory reform are going to introduce a whole new level of operational complexity which few buy-side firms are prepared for.

In this new dynamic environment, buy-side firms will be required to manage multiple relationships with different Prime Brokers (PB)/Futures Clearing Merchants (FCM), central counterparties (CCP) and counterparties. Each relationship involves different products, services and operational flows,
which are evolving at different rates in different jurisdictions, and subject to different regulators. In order to maximize these relationships, buy-side firms will need leading-edge operational tools that can provide a consolidated view and deliver:

• efficient margin management to support increasing volumes (e.g. margin calls, wire payment, portfolio reconciliations) and minimize operating costs
• effective risk management
• capital efficiency

Maximizing capital efficiency in this environment will be exceptionally challenging. Many buy-side firms will be required to post more and higher quality collateral. Key priorities will be:

• firm-wide collateral management and optimization processes which will improve the visibility and efficient use of available collateral and collateral transformation services offered
• leveraging cross margin capabilities
• forecasting Treasury and Funding needs
• limiting collateral movements with the ultimate goal of maximizing profitability and liquidity

The ability to efficiently manage and post collateral at a lower cost will become the defining competitive advantage.

In the quest to conquer these challenges, some leading buy-side firms have started to reorganize their operating model but many are relying heavily on their PB/FCM relationships, third party technology vendors, and Collateral Service Providers for solutions to these complex problems. These solutions in many cases are still a work in progress with the final rules pertaining to margin and collateral requirements expected in the coming months. It is time for hedge funds and buy-side firms to take action.

Key Questions

• Is your organization operationally ready for the challenges and complexities that come with regulatory reform in a multi-PB model?
• Do you have a centralized collateral management solution that provides a view across all products and entities to maximize collateral optimization and to enable more effective liquidity and capital management?
• Is there an opportunity through operational transformation to consolidate margin silos and streamline service providers?

What should the buy-side be doing?
In preparation for regulatory reform in a multi PB Model, buy-side firms should be:

Regulatory reform: Evaluating the impact of Regulatory Reform, for cleared and
non-cleared derivatives, for their business, operating and economic models.

Standard SCSA: Assessing the SCSA to determine if it is economically viable and
to evaluate its impact on their operating model.

Legal agreement framework and on-boarding: Determining the impact on the
legal agreement framework, on-boarding process, and identifying clients where the
legal agreements will need to be negotiated.

Operational transformation: Reviewing current state, defining and implementing
a new target operating model that can support regulatory reform in a multi-PB
Model and provide a consolidated view across PBs/FCMs and CCPs. This should
address the following needs: 1) service, functions and process; 2) organization and governance; 3) technology; 4) sourcing and location; 5) performance management; 6) people and skill sets; 7) global foundation that can support long term EMIR and MIFID if needed.

Collateral management and optimization: Establishing system infrastructure
and processes to: 1) provide centralized visibility to firm-wide collateral; 2) optimize
the value and use of collateral; 3) maximize cross margining opportunities offered
by PBs/FCMs and CCPs; 4) forecast funding and treasury needs; 5) limit number of
collateral movements; 6) provide liquidity and contingent risk management.

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