Untethered Solutions Puts Collateral Optimization at Risk

ActiveViam |
November 16, 2022

As interest rates have risen and cash is no longer allowed to be used to post collateral, an integrated approach to collateral optimization is very much on the minds of all stakeholders involved in front-to-back risk trade processing. Risk managers and traders will want and need to be more involved in managing the collateral since it is so critical to boost revenues and reduce costs. Many firms are finding that this is no longer a simple “back-office” function.

That being said, it can prove difficult to achieve as so often senior managers are faced with an array of existing underlying systems that need to be consolidated to produce a single view of the collateral inventory. In many cases, this is achieved using spreadsheets that struggle to provide the analytics that are so critical for efficiently managing  and optimising collateral in an efficient and timely way.

Overall, the right software solution will enable the easy aggregation, optimization and analysis of large volumes of complex, dynamic data enabling firms to perform deep-dive and scenario-based analytics and really understand their margin exposure and cost of trading. 

Once banks and buy-side firms alike have a clear view of their collateral positions they can free up cash to trade. This approach also potentially saves traders hours every week as they no longer need to work out the best collateral for every trade and can instead concentrate on making profits.

There are clear practical advantages to adopting a flexible solution that adheres to a firm’s technology architecture and sits atop its existing systems while drawing the necessary data out. 

Such a solution may offer pre-built optimization algorithms (such as “CTD”, Cheapest to Deliver) to help ensure the deployment of collateral optimization applications in a matter of months. A flexible solution, over time, lets in-house business and IT teams  enhance it with their own algorithms as their collateral strategies evolve.

Banks can actively monitor and forecast margin levels to ensure limits and thresholds are managed effectively in real time. It is wise to move beyond traditional CEP (Complex Event Processing) software to ensure better-informed decisions through more advanced business logic. This type of software can also manage rules that trigger specific actions, for example to exclude certain assets when clearing cut-off times are reached, ensuring maximum optimization efficiency.

In terms of cost, simple allocation methodologies like preference ranking or haircut ranking are static and do not consider all the variables associated. Calculating – and therefore understanding – the cost of collateral depends on a clear view of transaction/settlement costs, transformation costs, haircut, lending rates, interest rates (etc.). With the right approach, strategies for collateral optimization can be based on dynamic models which consider all the costs and ranking variables that can vary on a daily basis. 


More next week on the solution that will help you optimize your collateral…

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