The Benefits of Effective Collateral

Management in Cleared Derivatives

Tucker Dona
Head of Business
Development and
Client Success

Ragu Raymond
Director of Business
Development and
Client Success

The effective management and deployment of assets has always been an
important factor in the performance of Futures Commission Merchants
(FCMs). However, until now it’s not been possible to achieve consolidated
connectivity to multiple central clearing counterparties (CCPs) to enable FCMs
to access real-time collateral and margin data – invaluable insight that can be
used to optimise and instruct collateral movements across CCPs globally.

Collateral Management in Cleared Derivatives: An Area Ripe for Disruption

Market volatility resulting from the COVID-19 pandemic fuelled trading activity
and led to a rise in margin requirements from CCPs – in some cases by more han 100%. Whilst recent activity has been more subdued, the backwardlooking risk models deployed by CCPs mean that high margin requirements
remain in place. This in turn, has led to increased pressure on FCMs to manage
collateral effectively, maximise liquidity, and reduce risk.

Within FCMs, the function of collateral management involves multiple manual
processes. Each CCP produces end-of-day reports in different formats and
communicates with FCMs via its own dedicated channels. Very few firms have
reliable access to the intraday data that can prove critically important in fast
moving markets.

Added to this is the need for FCMs to monitor collateral and assess risk,
optimise margin in line with tight CCP cut-off times, and check eligibility
of collateral with multiple CCPs. While an FCM can to some extent reduce
workload by setting its own criteria on the types and volumes of collateral
it will accept from its customers, in practice a client may only have certain
collateral to pledge. “And if an FCM won’t accept it, the client will look to go
elsewhere,” explains Ragu Raymond, Director of Business Development and
Client Success at Baton Systems. “So a lot of FCMs collect collateral but can’t
do anything with it. They’re reducing risk, but not maximising liquidity.”

“Another issue is time zones,” Raymond says. “It can take up to three days
to move collateral from EMEA to APAC, and this can prevent firms from
responding to margin calls in a timely and efficient manner.”

“The automation of these
processes reduces costs,
increases
capacity and
workflow
efficiency and
has a positive
impact on the
firm’s overall
liquidity profile.”

Every transfer of collateral therefore requires significant operational input.
This limits the number of transactions which can be performed and further
reduces efficiency.

Technology is the Key

Respondents to a Futures Industry Association survey¹ conducted Q1 2021
cited collateral management as an area where technological innovation and
modernisation is needed. There is a growing need for technology which can
provide a single, comprehensive and accurate view of exposures and obligations.

“Baton’s platform sits between the FCMs and the CCPs,” explains Tucker Dona,
Baton’s Head of Business Development and Client Success. “The technology
eliminates many of the existing manual working methods which impede FCM
decision making, by providing real-time visibility of collateral, along with excess/
deficit calculations and eligibility rules, haircuts and the risk thresholds for
individual CCPs.

“The automation of these processes reduces costs, increases capacity and
workflow efficiency and has a positive impact on the firm’s overall liquidity profile.”

Reducing the reliance of an FCM on manual processes and checks allows
optimal decisions to be made about the movement of assets, resulting in
significant economic benefits for the firm. Using Baton’s technology, an FCM
can implement automated rules and alerts to move specific, eligible collateral
to and from CCPs based on intraday data, meaning that the excess collateral
maintained by a firm at any given CCP can be reduced. In addition, Baton allows
an FCM to monitor the efficiency of existing collateral placements – for example,
by factoring in haircut changes or interest rates – thereby optimising the
decision-making process regarding placement of collateral.

Further, by automating the onward processing of collateral and tracking its
location in real time, an FCM is able to efficiently utilise all available client
collateral in custody, leading to improvements in funding and liquidity.

¹FIA Industry Sentiment Survey Q1 2021,
www.fia.org/sites/default/files/2021-03/IndustrySentimentSurvey_Q1-2021%20Highlights.pdf

Looking to the Future

Baton is focusing heavily on building out CCP connectivity. “We don’t require
much work from the CCPs,” Dona stresses. “I believe the CCPs are coming to
realise the value of having one consolidated source of instructions. It means
there are fewer problems for them to solve.”

Going forward, Dona is keen to explore the use of Baton’s technology in the
connectivity between FCMs and their clients. By using Baton’s technology across
multiple FCMs, clients and FCMs can replace existing email processes and have
a better real-time view of the status of pledges and recalls. For Baton’s FCM
clients, this will also reduce the manual processing role of the FCM and ensure
that assets are moved in a timely and efficient manner.

Empowering Trading

It is clear that, with multiple legacy systems and manual processes in place, it
is becoming increasingly difficult for FCMs to maintain control of collateral and
manage risk. The inability to act swiftly and the constraints of working with CCPs
across multiple time zones consistently leads to delays, missed opportunities
and trading inefficiencies.

Whilst some firms remain reluctant to replace existing systems, citing risk and
cost as potential barriers, Ragu Raymond is adamant that existing collateral
management infrastructures are hampering growth.

“At Baton, we can’t dictate strategy to an FCM,” Raymond says. “But we can
educate them about the benefits of streamlining processes and gaining real-time
insight that can be used to optimise decision-making and collateral placement.”

“If everyone becomes more efficient,” he adds, “it would release idle collateral so it
can be more effectively deployed – which can only be a good thing for individual
firms and the industry as a whole.”

About Baton Systems

Founded in 2016 by technology, payments and capital markets veterans,
and backed by venture capital, Baton Systems is reforming how payments
are made in the world’s largest financial markets.

By delivering on-demand synchronisation and orchestration of asset movements
through its distributed ledger-based platform, Baton is eliminating friction to
speed clearing and settlement, reducing risk and pre-funding requirements, and
increasing liquidity.