The Future of Collateral Management: Where Do We Go from Here?

The UMR scramble may be behind us, but the need to improve and automate collateral management systems and processes remains critical.

It’s been 13 years since the passage of the Dodd-Frank Act in the US, and seven years since the first phase of UMR (Uncleared Margin Rules) started going into effect for the largest entities in 2016. The final phase of UMR came to pass in September of 2022, and while UMR will never be truly “over” (new entities come into scope each year), it’s natural for many in the industry who have been heads down working on the planning and implementation of UMR for all these years, to look up at this point and ask, “What now?”

The answer to this question may become clearer as we take a step back to look at the processes that were put in place in the rush to get compliant with UMR. In many cases, manual processes were stitched together to compute daily margin calls, calculate collateral amounts, settle those collateral movements, identify disputes, produce EOD risk reporting, etc. Some of these manual processes were stacked on top of the manual processes that already existed in the pre-UMR collateral workflow. In the haste to get compliant, many organizations were forced to focus on the needed result, with less focus on how that result could be attained efficiently.

The future of collateral management

Disruption through process

So, “what now?” Well, now that we, as an industry, have done what was necessary to attain compliance, the focus now turns to doing it better. Automation and efficiency become the hot-button topics, as firms turn to technology partners to help them move into the next phase of the collateral management journey.

A good place to start is with the daily margin call workflow itself. Too often, these workflows are dependent on a person clicking dozens, sometimes hundreds, of times to review, issue, and respond to daily margin calls. In many cases, this process can be partially or completely automated. When a margin call is received electronically, the amount of that margin call can be automatically compared to the receiving firm’s internal books and records to determine the extent to which that firm agrees, partially agrees, or disputes that margin call. That response can be sent back to the issuing party automatically, with no clicks needed. The resulting collateral movement can also be booked and processed automatically. Similarly, margin calls can also be issued automatically. As responses to those calls are electronically received, those responses can be automatically processed as well. While it’s prudent to put some parameters around this automated workflow to ensure that bad data isn’t processed without sufficient oversight, it’s very possible to achieve a workflow where only those exceptions require manual intervention, resulting in a far more efficient process than we typically see today.

Disruption through technology

Another area where it’s possible to achieve greater efficiency is in the mobility of the collateral itself. Distributed ledger technology (DLT) makes it possible to move assets 24/7, eliminating the typical afternoon rush to beat the Fed deadline. Immutable proof of settlement is also visible to all participants using this technology, making the old process of chasing down Fed reference numbers obsolete. While most in the industry aren’t quite ready (or willing) to use cryptocurrencies as collateral, there are other ways to utilize DLT and blockchain technology to achieve this kind of efficiency with collateral mobility. Tokenizing assets that are already generally accepted as eligible collateral, such as treasury securities or money market funds, can be a good entry point. This idea is gaining mainstream acceptance. ISDA has published papers that broach this topic, and the Depository Trust and Clearing Corporation (DTCC) recently completed the acquisition of a company called Securrency, which focuses on tokenizing assets on the blockchain.

While using tokenized digital assets for collateral mobility seems like the most immediate use for DLT and blockchain technology, it’s certainly not the only conceivable use case. When we think about a process that injects the most inefficiency into the daily collateral process, it’s probably dispute management. An inordinate amount of time and effort is put into reconciling portfolios to find the root cause of differences. Artificial intelligence can help to do this quicker, and that is a good first step. But even when the breaks are automatically highlighted, there are still breaks. It isn’t a stretch to imagine firms using DLT and blockchain technology to define the contents of a portfolio of positions between parties, including contractual terms, such as independent amount. When the portfolio of positions on the blockchain is viewed as the single source of truth, reconciliation becomes obsolete.

While some of these applications of technology may seem futuristic, the fact is that the technology exists right now. As the dust has now settled from the UMR focus of the past decade, the industry seems primed to move more quickly into the direction of increased automation and efficiency. The future is here.

Questions for consideration:

Q: How can firms ensure that the transition towards increased automation and efficiency in collateral management doesn't compromise security or oversight, particularly when implementing automated workflows?

A: In ensuring the transition towards heightened automation and efficiency within collateral management, firms must maintain a vigilant stance on security and oversight. Most solutions will allow for the creation of exceptions, which are items that fall outside the definition of what would be considered “typical”. The rules governing what constitutes “typical” should be narrow at first, with exceptions being excluded from the automation process. In time, the exception rules can expand until the right balance is found. Striking this balance between streamlining processes and upholding regulatory standards remains paramount in this evolution.

Q: While the article discusses the potential of DLT and blockchain technology for collateral mobility and dispute management, what are the major obstacles or challenges that firms might face in adopting these technologies on a wider scale?

A: The integration of DLT and blockchain technology presents promising avenues for collateral mobility and dispute resolution. However, firms are likely to encounter significant hurdles in adopting these technologies on a broader scale. Addressing concerns related to regulatory compliance, interoperability with existing systems, and the establishment of industry-wide standards are pivotal challenges that need to be navigated effectively. Furthermore, widespread adoption of these new technologies will be necessary to create the economies of scale needed to fully realize the efficiency gains these technologies can offer.

Q: Beyond the examples provided in the article, what are some other potential applications of emerging technologies like artificial intelligence, DLT, and blockchain in collateral management that could further enhance efficiency and risk management in the future?

A: Beyond the scenarios delineated in the article, the horizon brims with potential applications of cutting-edge technologies such as artificial intelligence, DLT, and blockchain in collateral management. Exploring novel avenues like predictive analytics for risk assessment, smart contract implementation for automated collateral agreements, and further enhancements in data reconciliation through advanced algorithms represent additional frontiers for innovation in the field.

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