Bank’s perspective on regulatory-driven changes to collateral management
| Date | 06 May 2014 |
| Pages | 128-146 |
| Published date | 06 May 2014 |
| DOI | https://doi.org/10.1108/JFRC-07-2013-0025 |
| Author | Lukasz Prorokowski |
| Subject Matter | Accounting & Finance,Financial risk/company failure,Financial compliance/regulation |
Bank’s perspective on
regulatory-driven changes to
collateral management
Lukasz Prorokowski
Risk Management, Lepus – Investment Banking Consultancy, London, UK
Abstract
Purpose – The aim of this paper is to discuss the impact of regulatory-driven changes to the collateral
management landscape, indicating operational and technological challenges faced by global
investment banks while complying with the new regulatory framework. As it transpires, collateral
management strategies need to be revised to nd optimal solutions for the regulatory-shaped
landscape. Furthermore, set against the regulatory background, this paper attempts to provide some
insights into the future risks and shocks to collateral management.
Design/methodology/approach – This paper recognizes the dearth of up-to-date studies on current
issues with collateral management and overnight indexed swap (OIS) discounting. Therefore, to
introduce new theoretical avenues, this paper is based on an exploratory, qualitative approach to
analyse the regulatory-driven collateral management.
Findings – The increased use of collateral, with a sharp focus on its quality, liquidity and eligibility for
central clearing, requires a new approach to collateral management and discounting methods. At this
point, banks (especially those with agency businesses) should develop an enterprise-wide view of
collateral by having a central data repository, which allows access to information about the transactions
conducted with all counterparties.
Originality/value – Analysing the regulatory-driven (Basel III; Dodd-Frank; EMIR) changes to
collateral management, this paper adopts banks’ perspectives on the new regulations in collateral
management. The paper contributes to the widespread, albeit complex, discussion on how banks adapt
to the rapidly changing environment in collateral management and risk operations.
Keywords Basel III, Banks, Collateral management, EMIR, OIS discounting, Central clearing,
Dodd-Frank, Operational risks, OTC transactions
Paper type Research paper
1. Introduction
This paper aims to highlight regulatory-driven changes in the collateral landscape. In
doing so, the study sheds light on the nascent challenges in the area of collateral
management from the perspectives of agency and principal businesses. Embarking on
semi-structured interviews with senior-level practitioners from nine banks, the study
analyses how the prevailing monetary policy and new regulations in the form of Basel
III, Dodd – Frank, Solvency II and EMIR affect collateral management activities in the
post-crisis era. As it transpires, nancial institutions are required to comply with the
The article has been supported by Lepus, founded in 1997 to provide research, consulting and
marketing services to the nance industry. Concentrating mainly on investment banking, Lepus
also offers services in the retail, insurance, asset management, corporate and hedge fund sectors.
Lepus’ success is founded on its ability to provide its clients with a service which is expressly
geared to their individual requirements.
The current issue and full text archive of this journal is available at
www.emeraldinsight.com/1358-1988.htm
JFRC
22,2
128
Journal of Financial Regulation and
Compliance
Vol. 22 No. 2, 2014
pp. 128-146
© Emerald Group Publishing Limited
1358-1988
DOI 10.1108/JFRC-07-2013-0025
new regulatory frameworks. Moreover, the crisis-induced changes to monetary policies
are altering the collateral landscape. To this end, the regulatory changes may constrain
the availability of collateral that underpins nancial transaction. In this paper, we
investigate how the surveyed banks are dealing with the regulatory-driven changes in
the global nancial system.
By adopting practitioners’ perspectives on collateral management, this paper is
focused on the positive and negative factors that shape the new collateral landscape.
The study contributes to the widespread, albeit complex, discussion on how banks
adapt to the rapidly changing environment in collateral management and risk
operations. Hereto, the current decline in the re-use of collateral may be viewed
positively from a stability perspective (policymakers and nancial regulators).
However, as far as practitioners (banks and nancial institutions) are concerned, the
new collateral landscape constrains the availability of collateral eligible for bilateral
derivative trades and liquidity requirements.
Analysing the regulatory-driven changes to collateral management, this study
addresses a relatively sensitive topic of overnight indexed swap (OIS) discounting set
against the background of the global nancial turmoil and unprecedented organized
fraud with London interbank offered rate (LIBOR). On one hand, we are provided with
evidence of manipulations in LIBOR submissions that urged the global nancial
community to call for reform. On the other hand, we hear the “untold stories” of the
fortunes made by those who switched to the OIS discounting well in advance and, by
and large, used it to their own advantage.
All in all, as a result of the recent scandals, the banking industry is faced with the
move towards OIS discounting. However, this rapid regulatory change imposes
challenges even on the tier-1 investment banks. The paper aims to discuss the nascent
constraints and advantages of using OIS discounting. In doing so, the paper indicates
how the surveyed banks have adopted to the new regulatory-driven reality.
This paper explores the strides major banks are taking to introduce OIS discounting
methods while complying with the new regulatory requirements. Furthermore, it
investigates how external factors impact on credit support annex (CSA) risk
management.
This paper is structured as follows: Section 2 presents a study background for the
collateral management and OIS discounting. Given the nascence of the issues discussed
in this paper, the scholarly literature underpinning the current collateral management
space is limited to the most recent working papers on collateral management published
by international nancial institutions as well as technical notes on OIS discounting from
nancial authorities. With this in mind, we strive to address the dearth of contemporary
studies analysing the accelerating change in collateral management by focusing on
issues that remain arguably under-researched but have recently become highly salient.
The remainder of this paper consists of a section (Section 3) providing details of the
qualitative research methods and informing how the ndings were gathered and
elaborated. Then, the ndings are presented in Section 4, which indicates the positive
and negative factors that are shaping the current collateral landscape. This section also
discusses how banks are dealing with the nascent changes to collateral management
and investigates risks associated with the new trend of transforming collateral
management into prot centres. The paper is summarized with principal conclusions
and implications for both the practitioners and policymakers (Section 5).
129
Banks and
collateral
management
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