To clear or not to clear – the challenges of funding and financing for the buy-side

To clear or not to clear – the challenges of funding and financing for the buy-side

By Richard Glen, SVP, Global Funding & Financing (GFF) Sales and Frank Odendall, SVP, Global Funding & Financing (GFF) Sales, Deutsche Borse Group.

Can you please tell the Center for Financial Professionals about yourself and your experience in the fund and asset management industry?

My name is Richard Glen and I am a senior vice-president within the Global Funding & Financing (GFF) Sales team at the Deutsche Boerse Group and responsible for collateral efficiency. This initiative focuses on providing clients with collateral management solutions that help them to meet their OTC and CCP margining requirements effectively as well as optimize collateral mobility across all securities financing products and venues. In the 11 years that I have been with the firm, we have supported many funds and their custodians / asset managers with the management and segregation of collateral, particularly with the onset of new regulations such as UCITS V and EMIR / DFA. We work collaboratively with many fund associations in Europe (ALFI, BVI) and global industry associations (ICMA, ISLA, ISDA) and help the market to develop solutions leveraging trading, risk management and post-trade infrastructure.

My name is Frank Odendall and I started out developing tailor-made hedging structures for corporates, public sector entities and pension schemes using interest rates swaps when working for JPMorgan. At Deutsche Boerse Group, I initially helped develop the client centric interest rate swap clearing offering at Eurex Clearing which at the time contained the first individual client segregation model. After that, I worked in the listed derivatives product development group in Europe and Asia working closely with asset managers and banks on innovative products, e.g. a Money Market Futures hedging repo interest rates. Since 2016, I lead the team responsible for distribution of our CCP cleared repo solutions for buy-side entities, Select Finance, which for the first time enables asset managers, pension funds and insurance firms to access the highly liquid CCP cleared interbank repo market.

Can you briefly give us an insight in to the implications for the buy-side from a collateral and cash management point of view?

Regulatory change, whether it be those guidelines that have been implemented or future planned changes, impacts the buy-side on multiple layers. Mandatory clearing of certain derivatives and the introduction of the uncleared derivatives margin rules are expected to greatly increase the demand for collateral and cash financing. Meanwhile, banks are confronted with significant capital constraints and are under pressure to cut the provision of services to their clients in order to reduce costs. As a result, buy-side firms are forced to optimize the use of collateral across different trading venues and locations, consolidate and net exposures from their derivatives trading activities if possible and enhance the mobilization of collateral. However, above all, the buy-side will need to ensure a cost efficient and timely access to cash liquidity or collateral transformation services (repos) in order to match the more stringent variation margin payment obligations from trading derivatives going forward.

Without giving too much away, why has the sell side been forced to manage financing differently?

Collateral is at the core of all global funding and financing initiatives and sell-side firms have been impacted the most by the changing regulatory landscape. The need to maintain liquidity buffers has increased the demand for high-quality liquid assets (HQLA) as firms have sought to evidence stronger balance sheets and prove stress test resilience. In addition, changing liquidity and leverage guidelines have forced firms to manage their collateral, in particular less liquid assets and the associated term funding requirements, more closely. The increasing need to post margin for OTC derivatives, whether this to be to a CCP or to a bilateral counterparty, will exacerbate the situation; however, it also forces firms to evaluate how they can access liquidity more effectively and also utilize technology to help drive more of their trading and risk management decisions.

What are some of the key challenges of funding and financing for the buy-side?

Buy-side firms are being impacted more and more as a result of the changes that sell-side firms have been forced to make. Increasing capital constraints are hitting bottom-line costs and sell side firms are actively encouraging their buy-side clients to compare more cost efficient central clearing opportunities with bilateral trading options. Central clearing not only provides buy-side firms with efficient access to liquidity but also eases documentation requirements, something which continues to remain a concern for many firms that trade OTC derivatives. The immediate challenge of managing collateral also needs to be considered. Should a buy-side firm look at outsourcing the collateral management function? Does it have access to sufficient liquidity providers? How can it optimally finance their assets and portfolios? And how much will all of this cost? Choosing the right partners and providers will be critical as buy-side firms look to leverage safe, scalable solutions at a cost that makes sense for their stakeholders.

How do you see the role of the fund and asset professional evolving over the next 6-12 months?

We believe that there will be an increased focus on cost/benefit analysis of certain strategies as the new collateralization and clearing requirements provide for greater transparency on the cost side and might force a firm into re-thinking how they access funding and financing markets. We would expect some sort of move from OTC into listed derivatives and voluntary clearing as banks adjust their pricing to the new regulations and as maintaining multiple bilateral relationships becomes more and more cumbersome and expensive. At the same time, we would expect opportunities for asset managers in tapping new, more operationally efficient and stable sources of liquidity, e.g. direct access to interbank repo markets or securities lending via CCP.