Growing Global Collateral Pool: Will Fund Managers Profit?

With collateral potentially becoming a scarce resource over the next few years, securities depositories are quickly stepping up to the plate to ease access, but it remains uncertain just how much their new services will help the most needy: fund managers.

The announcement of the alliance between two mega market infrastructures — international securities depository Euroclear in Brussels and the US’ Depository Trust & Clearing Corp. — drew plenty of attention from the hundreds of fund management firms attending SWIFT’s annual SIBOS conference in Boston this week who are waiting for conclusive evidence on how they will benefit. The consensus among middle-office executives at ten fund management firms speaking with FinOps Report: sounds great, but no cigar.

Still, fund managers are holding out hope they could eventually benefit based on further information released at the SIBOS gathering on the new initiative launched as a joint venture in London called DTCC-Euroclear Global Collateral Ltd. “It sounds promising, but we don’t think fund managers would be allowed to directly use the service when launched,” one collateral management specialist at a US fund management shop tells FinOps.

Savings or New Costs?

Such a restriction would leave buy-side firms depending solely on bank and broker-dealer participants of DTCC and Euroclear to potentially rely on the collateral service to help their end clients. Buy-side firms are not members of either Depository Trust Company, the US national securities depository subsidiary of DTCC, or Euroclear, but they could possibly end up with lower fees for collateral optimization and transformation services if  their service providers pass along any economies of scale to be found in the joint venture’s services. “It’s a big if,” says an operations manager at another US fund management shop.

With regulators in every corner of the globe wanting far more transactions collateralized to reduce systemic risk, fund managers are in a bit of a pickle. In the case of trades involving swap contracts they may have never needed to use initial and variation margin, so they could easily make due with the collateral they had on hand for an array of other transactions. As those over-the-counter derivative contracts must now be processed through central clearinghouses — acting as middlemen or guarantors of sorts — fund managers will have to find additional collateral to meet not only initial margin requirements, but comply with an exponential growth in margin calls, or requests for additional collateral from their clearing brokers and clearinghouses to meet variation margin requirements. Even worse, they have to do so at record speed — intraday or close to real-time.

In responding to questions posed by FinOps Report, top-level officials at the DTCC and Euroclear involved in the joint venture naturally touted its efficiencies, but did confirm that fund managers will not have direct access to the new service. “The joint venture will work in collaboration with custodians on both sides of the Atlantic,” says Mark Jennis, managing director of strategy and business development at DTCC who will become executive chairman of the new joint venture. “The custodians will have a contractual relationship with the JV, but the assets can be held in either DTCC or Euroclear, or in the case of the Margin Transit Utility (MTU), directly with custodians.”

Working through Gatekeepers

Likewise, confirmed Jo van der Velde, managing director and head of product management at Euroclear who will become a member of the board of the new joint venture: “Fund managers can access the services of the JV through their custodians or fund administators.”

Euroclear and DTCC first discussed the new joint venture last year in touting a memorandum of understanding, but have apparently ironed out further details as evidenced by their joint press statement and comments to FinOps on how the new firm would work. In the initial incarnation, explains Jennis, the MTU would provide “straight through processing of margin obligations, including margin calls between market participants, creating appropriate settlement instructions for cash and securities transfers and pledges.” The MTU will focus first on US dollar-denominated securities and cash, with European denominated securities and cash following at a future time. Collateral can be sourced from either the DTCC, Euroclear or directly from the books of custodians, says Jennis.

Although such language on straight-through-processing and calls prompted some fund management operations specialists to speculate about whether the MTU will compete with AcadiaSoft, the Boston-based firm insists the two initiatives will coexist. “AcadiaSoft’s MarginSphere will integrate with Margin Transit to pass its agreed margin movements into the settlement process,” says Chris Walsh, chief executive of AcadiaSoft. Used by some of the world’s largest broker-dealers and fund administrators, MarginSphere receives trade positions and information on margin requirements from counterparties, matches margin requirements and call amounts, handles the pledging and acceptance of collateral to cover agreed call amounts, and handles any discrepancies and disputes.

The second and final part of the joint venture between the DTCC and Euroclear, called Collateral Management Utility, appears to leverage Euroclear’s existing  Collateral Highway, which already allows clients of custodians such as BNP Paribas, Standard Chartered and Citi to use securities held at one of those banks to back any transaction for which Euroclear serves as the triparty agent. The hook-up between Euroclear and DTCC would extend that scenario to other custodians, depositories and even international securities depositories such as Clearstream to join the “open service” or industry cooperative and include the collateral on their books as part of an international pool of collateral.

Bottom line: DTCC and Euroclear want to solve the collateral logjam faced by market players by allowing them to access collateral quickly across the globe whenever necessary to meet collateral and settlement obligations. The collateral held at either depository can be thought of as if it were in a single pool and others could grow that pool.

Going Global

Here is how the endgame is described in greater operational detail to FinOps by van de Velde: “The CMU will provide industry participants with the ability to consolidate their assets under a single inventory and collateral management system for the purposes of automatic and optimal allocation of mutualized assets in both the European and North American time zones. The assets remain on the books of each depository, with each opening accounts in the other depository and collateral allocations will be seamlessly integrated with settlement obligations at the other depository significantly reducing the risk of blockages and settlement failures during market stress conditions.”

The cooperation between DTCC and Euroclear isn’t the only one of its kind, but based on the size of the two market infrastructures, it could have the greatest impact in relieving the current constraints in accessing and moving collateral to where it is needed to back a transaction. Collateral mobility helps with the process of collateral optimization — an industry buzzword for best use of what collateral is on hand — and might even reduce the need for collateral transformation or the exchange of low quality collateral for higher quality collateral. Fund managers often rely on their custodians or broker-dealers to provide such services as the costs of doing so in-house are often prohibitive.

Officials at Euroclear’s rival Clearstream were noticeably quiet when FinOps asked for comment on the joint venture between Euroclear and DTCC. However, the Luxembourg-based international securities depository has previously touted its white-label agreements with other national depositories to help their members collateralize their transactions in their home markets using Clearstream’s service Global Liquidity Hub. Anthony van Eden, strategic projects director for South Africa’s depository Strate, says that so far ten bank and broker-dealer participants of Strate are testing Strate’s new collateral management service which relies on Clearstream’s technology. However, uptake could be stymied by a local tax on the transfer of securities unless the securities depository reaches an agreement with South Africa’s tax authority to consider the transfer of collateral to a depository member as a transaction offsetting a liability.