Over the past few years, there has been a heightened interest in collateral management. Investment managers have been under pressure to significantly strengthen their processes and controls in this area. But, it is widely recognized that collateral management is fraught with many issues and challenges. Firms have come to realize that their current processes and systems, which are often manual and highly fragmented, are not adequate from a control and operating efficiency standpoint.
IntegriDATA conducted an independent survey on collateral management practices to assist industry participants in benchmarking themselves as well as determine best practices. The respondents included Operations Managers and C-level executives of buy-side investment firms. The respondents firms varied in size and were grouped into AUM categories (i.e. under $1 billion; $1 to $5 billion; $6 to $10 billion; $11 to $25 billion and over $25 billion).
The overall findings are as follows:
- Non-Standard Broker Data – as with every business process, data capture and standardization is a critically important prerequisite for process effectiveness. Non-standard file and data formats, as well as lack of robust delivery methods, hamper the ability to achieve a high level of process automation
- Adoption of Specialized Software – larger firms utilize specialized applications software, while small to medium sized firms use Excel to varying degrees. End to end automation is rare for all firms
- Use Highly Skilled Staff/Achieve Acceptable Control Levels – given the process complexity and the potential financial consequences associated with errors, highly skilled knowledgeable workers tend to be used to overcome the inherent data and systems limitations
Current State of Technology
The survey revealed that 76% of the total firms have some type of a central repository that hold some or all of their collateral and margin data. Of these, 44% utilize third party software; 38% have a propriety database, and the remaining 18% store their data in Excel. Just over half of the firms which use Excel have AUM of $5 billion and under (evenly split between firms of under $1 billion and $1 to $5 billion AUM).
With respect to investment into technology, overall spending anticipated for 2010 versus that spent in 2009 will be the same for 73% of the firms, with 18% increasing and 9% decreasing their investments. However, of the smaller firms (AUM of $5 billion or less) with 2009 and 2010 technology budgets, spending for those firms will increase for 20% and remain the same for 80%.
Major Pain Points in the Collateral Management Process
Despite the fact that a large number of firms have a system in place (as indicated earlier), 50% of the total number of respondents stated that they still restrict trading in derivatives to a limited number of brokers due to data and technology limitations. In fact, 73% of the respondents who restrict their trading do have a system in place – and these included an almost equal proportion of firms from each AUM category. It is important to note that 93% of the firms who restrict trading rate their ability to complete their collateral management process as either timely or very timely. However, the majority of those respondents do not consistently redeploy excess collateral at their brokers.
The top pain points identified were as follows:
- Broker files not leverageable for automated data extraction (56%)
- Non-standard broker file formats/layouts (52%)
- Lack of industry standard financial instrument ID’s for matching (64%)
Functionality Most Desired
In view of the challenges, greater recognition is anticipated to be given to an automated approach to collateral management putting specific functionalities of the available systems in the spotlight. According to the survey, the following three functionalities were ranked as the most vital when choosing a system:
- Central repository for all collateral & margin related data (80%)
- Position holdings matching and margin reconciliation (75%)
- File collection and data transformation/normalization (61%)
Reporting and Risk Management
Considering the importance of risk management, surprisingly less than 50% of the firms indicated providing daily exposure reports to management. Yet, just over 60% of the respondents stated they have either very strong or a strong level of internal controls; another 20% considered their internal controls average. In both instances, responses were almost equally shared between firms across all AUM categories. The remaining 20% of the responses, indicating fair or weak level of internal controls, all belonged to firms with under $1 billion AUM.
Best Practices Achieved
According to the survey, despite the challenges and technology limitations, a significant number of firms perform daily execution of the operational risk management exercises. The results were as follows:
- Reconcile Collateral (63%)
- Verify Broker Margin (63%)
- Match/Reconcile Holdings (60%)
It is important to note that the high results are almost equally shared between firms from all the AUM groups.
Given impending regulatory pressures, it is highly probable that a great amount of the collateral management pain will disappear as more derivative trading migrates to regulated exchanges. That being said, this will not happen overnight, nor will it occur for all activity. Clearly, solving for the broker data conundrum is an imperative for realizing meaningful process improvements in collateral management. However, it is unlikely that the brokers will conform to a standard. This leaves the challenge to the investment management community – be it participants, software vendors or outsource providers.