Collateral management for the buy side – Algorithmics survey identifies weakness in current systems and concern about impact of central counterparty clearing on buy side

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New survey of collateral management practices in 80 buy-side organizations found weakness in some collateral processes and concern among firms about the impact of central counterparty clearing on the buy side.

This survey confirms that the buy side has basic collateral management processes in place and sophisticated ambitions in areas such as collateral optimization.However, the low incidence of daily margining reveals the absence of some basic risk processes.

Algorithmics today announced the findings of a new survey of collateral management practices and challenges in buy-side institutions around the world, which found weakness in some collateral processes and concern among firms about the impact of central counterparty clearing on the buy side.

The survey, ‘Collateral Management for the Buy Side: Emerging Challenges and Best Practices in a Changing Regulatory Environment’ was conducted by Algorithmics, the leading provider of risk solutions, and Chromozome Consulting, the collateral management and derivatives consultancy, and features responses from 80 buy-side institutions around the world, including asset managers, hedge funds, pension funds and custodians.

Dr Andrew Aziz, Executive Vice President of Risk Solutions at Algorithmics, commented: "We have seen collateral management practices in buy-side firms evolve rapidly in the years since the financial crisis. Add to that the new requirements of the changing regulatory environment and it becomes clear why the buy side continues to experience increased growth in requirements around the collateral management process.”

Neil Murphy, director, Collateral Management, Algorithmics, added: “The findings of this survey confirm that the buy side has basic collateral management processes in place and sophisticated ambitions in areas such as collateral optimization. However, the low incidence of daily margining reveals the absence of some basic risk processes that will become increasingly important in the new world of central counterparties. Our respondents are already realizing that central clearing will not be a collateral ‘cure-all’ but will add to costs and collateral process requirements. The buy side will need to address any gaps in their collateral process now if they are to contain costs and meet this regulatory challenge.”

Key survey findings were in five areas:

1.    Margining - too infrequent, with 54% of respondents making weekly margin calls only
2.    Central counterparty clearing (CCP) - impact is still unclear but will increase costs and efforts
3.    Collateral optimization - 25% of respondents were interested
4.    Significant growth in collateral requirements regardless of CCP impact
5.    Eligible collateral - 55% want to use equities as eligible collateral.

1. Weak process - weekly margining heightens risk exposure
54% of respondents are making weekly rather than daily margin calls – and this is despite 84% using vendor or outsourced collateral management systems. Weekly margining exposes firms to potentially increased levels of risk, as daily changes in exposure remain uncollateralized. Weekly margining will also not meet the need for more frequent margining that central clearing will require.

2. Views on central counterparty clearing (CCP)
Institutions await full clarity on how central clearing will work in practice for the buy side but it is clear that CCP clearing will put further pressure on organizations’ day-to-day collateral processes as they need to manage more collateral contracts, with increased collateral funding needs, and with more frequent margin calls. Asked how CCP would impact bilateral collateral activity, 56% of respondents expected to need more collateral and 25% expected to see more counterparties collateralized.

3. Appetite for collateral optimization
25% of respondents were interested in optimizing collateral. At a time when the costs of collateral funding may increase, this comes as no surprise: optimizing collateral offers a way of minimizing collateral cost through efficient re-use of collateral balances. For the same reasons, 22% cited a need to measure concentration limits on collateral positions as a key priority.

4. Growth in collateral requirements
Several factors, including increased agreement volumes, larger portfolios, and greater use of initial margin, have contributed to the growth in collateral requirements. These were confirmed by the survey respondents, of whom 75% had between 100 and 500 CSA pairs, 75% had portfolios in excess of 500 live OTC positions and 72% use initial margin with 50% or more counterparties. In addition, 43% intend to validate the margin calculated by a clearer when they clear through CCP.

5. Interest in expanding types of eligible collateral
Survey respondents would like to use assets that they already have in their portfolios as alternatives to current eligible collateral asset types (such as cash, government or corporate bonds). 55% of respondents would like to use equities and 32% share of funds. However, central clearing houses are likely to require cash and high quality bonds.

Dr Andrew Aziz concluded: “This is an interesting evolutionary time for buy-side collateral professionals. For the first time, they are being held to the same operational and risk standards as their sell-side professional counterparts due to regulatory influences. Market changes may require buy-side firms to seek increasingly sophisticated services from their sell-side counterparties and third party service providers. From this snapshot of the buy side, it appears that some are better positioned than others to react to these changes, while others still need to focus on strengthening their fundamental processes.”

Neil Murphy of Algorithmics will present the findings of this report at a webinar on the 14th July, 2011at 10am EST, 3pm BST, 4pm CET. The webinar will be chaired by Paul Winter of Chromozome Consulting.

For a copy of the full survey and to register for the webinar, ‘Collateral Management for the Buy Side: Emerging Challenges and Best Practices in a Changing Regulatory Environment’, please visit: http://www.algorithmics.com/EN/publications/CMFTBS.cfm

For more information about Algorithmics’ award-winning collateral management solutions, visit:
http://www.algorithmics.com/EN/solutions/operations.cfm

For more information about Chromozome, visit: http://www.chromozome.co.uk

For further information please contact:

Heather Smith, Senior Communications Manager, Algorithmics (UK) Ltd
Direct line +44 (0) 20 7392 5820 Mobile +44 (0) 7515 974223
E-mail Heather.smith(at)algorithmics(dot)com

Notes to Editors:
Algorithmics’ survey of collateral management in buy-side firms, entitled ‘Collateral Management for the Buy Side: Emerging Challenges and Best Practices in a Changing Regulatory Environment’, was conducted in November and December 2010 via an online and telephone questionnaire in conjunction with Chromozome Consulting. Responses were received from 80 buy-side institutions around the world. The majority of respondents were asset managers and hedge funds (88% of total) and were based in Europe (69%), the US (22%) and Asia Pacific (9%).

For a copy of the full survey results and charts, visit: http://www.algorithmics.com/EN/publications/CMFTBS.cfm

Algorithmics is the world's leading provider of risk solutions. Financial organizations from around the world use Algorithmics' software, analytics and advisory services to help them make risk-aware business decisions, maximize shareholder value, and meet regulatory requirements. Supported by a global team of risk experts based in all major financial centers, Algorithmics offers proven, award-winning solutions for market, credit and operational risk, as well as collateral and capital management. Algorithmics is a member of the Fitch Group. http://www.algorithmics.com

Chromozome Limited is a niche collateral management and derivatives consultancy that delivers specialist derivative and collateral management consultancy services to investment banks, asset managers, fund administrators, hedge funds and custodians who understand the strategic importance of collateral management.

Collateral Operations is an enterprise-wide margining solution to guide banks, insurance providers, pension funds and asset managers through all aspects of the collateral management process. Through an automated workflow and timely access to market data, Collateral Operations enables financial institutions to respond faster to business opportunities while reducing credit and operational risk.

A flexible approach ensures the system can satisfy the needs of all collateral management programs regardless of size, including data gathering and consolidation, margin and collateral calculations, and the provision of data to downstream systems such as settlement and risk.

Portfolio Construction and Risk Management for Hedge Funds
Algorithmics has a range of risk solutions for all hedge funds irrespective of their strategy, level of sophistication or assets under management. With a clear migration path from pre-configured risk reports (Standard Edition) to fully customized risk systems (Enterprise Edition), Algorithmics can support our hedge fund clients as they develop and as their needs evolve. This means that hedge funds have the reassurance that their investment in the Algorithmics risk systems is fully scalable as their needs change in response to emerging client, regulatory, business model drivers.

Fitch Group is the parent company of Fitch Ratings, a global ratings agency committed to providing the world's markets with independent, timely and prospective credit opinions. With 49 offices worldwide, Fitch Ratings’ global expertise spans across capital markets in over 150 countries. Fitch Ratings is headquartered in New York and London.

The Fitch Group also includes Fitch Solutions, a distribution channel for Fitch Ratings products and a provider of data, analytics and related services; and Algorithmics, the world's leading provider of enterprise risk solutions.

The Fitch Group is a majority-owned subsidiary of Fimalac, S.A., headquartered in Paris, France.
For additional information, please visit http://www.fitchratings.com http://www.algorithmics.com and http://www.fimalac.com

© 2011 Algorithmics Software LLC. All rights reserved. ALGORITHMICS, Ai Logo, ALGORITHMICS & Ai Logo, ALGO, MARK-TO-FUTURE, RISKWATCH, KNOW YOUR RISK, ALGO RISK, ALGO MARKET, ALGO CREDIT, ALGO COLLATERAL, ALGO FIRST, ALGO ONE, ALGO FOUNDATION, ALGO FINANCIAL MODELER, ALGO OPVAR and TH!NK Logo are trademarks of Algorithmics Trademarks LLC.

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