Global Custodian Clearing and Settlement Issue 2018 | Page 8

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A N A LY S I S
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D I R E C T
C O L L AT E R A L ]
Collateral
fears still
loom large
Concerns over sudden surges of collateral
demands during volatile times have prompted buy-
side to move to a direct model with the CCP.
ears about being left unable to
acquire high-grade collateral
for margining purposes and the
counterparty risk that may be
incurred in the event of a clearing member
or clearing house default have long trou-
bled financial institutions.
Mandatory clearing prescribes market
participants post initial margin and varia-
tion margin in the form of cash or triple-A
rated government bonds as collateral to
central counterparties (CCPs). In addition,
margining requirements have since been
extended to financial institutions transact-
ing in bilateral OTC derivatives ineligible
for centralised clearing.
With so much high-grade collateral being
held at CCPs and banks accumulating large
quantities of HQLAs (high quality liquid
assets) due to Basel III’s capital rules, there
is growing alarm that financial institutions
would face huge difficulties identifying
pools of eligible collateral to post for mar-
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Global Custodian
Summer 2018
gining purposes at their CCPs.
However, an article by BNP Paribas
Securities Services published last year
highlighted that while concerns of a
collateral shortage have been defused, the
chief problem now is collateral velocity,
particularly during periods of market
stress when margin can be called on a
daily or intra-daily basis. “The biggest
risk OTC derivatives’ users will face is a
sudden demand for additional collateral
at times of severe market volatility,” read
the BNP Paribas Securities Services article.
To ensure there are no delays in posting
margin during periods of market volatility,
collateral management processes have to
be seamless.
Meanwhile, counterparty risk – despite
the tough balance sheet capital require-
ments imposed on banks and prescriptive
default waterfall processes at CCPs – has
not gone away. The big fear for financial
institutions is that collateral posted to a
CCP in an omnibus account is not suffi-
ciently safeguarded or identifiable and
risks getting trapped in an insolvency.
At the same time, if a clearing member
slides into default while collateral is in
transit, its clients will want assurances that
they have title over the assets, enabling
them to be returned or ported to another
clearing member or CCP. Such protections
can be enabled through individually seg-
regated accounts, but such structures do
come at additional cost.
The desire for safety and seamless col-
lateral management is one reason why a
number of custodians are throwing their
weight behind a new segregated account
structure established by LCH enabling
derivative users to post collateral directly
with the CCP, thereby retaining beneficial
title to the assets.
The LCH service – CustodialSeg – was
unveiled in August 2017 and requires
custodians or buy-side firms to open up