Nick Newport, Director, InteDelta
Many asset managers, hedge funds and small to medium sized banks are implementing robust collateral management systems for the first time, in order to support a wider focus on effectively managing counterparty risk. For many firms, the review of available software solutions is an arduous and confusing task. In this Q&A Nick Newport, director at InteDelta, highlights some of the key areas to be considered by financial institutions newly embarking on a system selection for a collateral management solution.
How do institutions make the decision whether to buy or build?
One of the first questions many institutions address when thinking strategically about collateral management technology infrastructure is whether to buy a solution from a system vendor or to build in-house. There are a number of different considerations in making this decision, however there is a clear market trend.
Whereas, amongst the very large investment banks the trend has historically been towards building collateral management technology platforms in-house, the picture is very different for much of the rest of the market. Where buy side firms and smaller banks are looking to implement a collateral management system, the most common choice is to select a vendor rather than embark on a project to build. The principal driver for this is the understanding that there has been a clear convergence to a common best practice in terms of business process within the collateral management market as a whole. Except at the leading edge institutions, which continue to expand the frontiers of best practice, the broad base of participants across the collateral management market have highly similar standards and processes. The collateral vendors have spent many years developing out their functionality capabilities to support these processes. As such, most organisations beyond the larger banks (and some of the more sophisticated hedge funds), don’t see value in duplicating this development.
Having said this, even when implementing a vendor system, making this successful is highly reliant upon building an experienced project team to work with the selected vendor and manage the overall implementation. As one of the key developments within collateral management over recent years has been the drive towards ever increasing levels of straight-through-processing (STP), interfacing to and from the collateral package is a key element of the project to be managed by the institution itself. At the very least, this will involve interfacing trades and valuations to the system and, for those organisations aiming at higher levels of STP, it will also include integration with other platforms such as settlement systems.
What are the main deciding factors for institutions when selecting collateral systems? Are these purely functional or do other factors such as technology or implementation approach also drive decisions?
In deciding on a collateral solution, there are a number of different factors that contribute to an institution’s final decision.
It probably goes without saying that one of the key factors is the functionality of the solution. Even for smaller organisations, collateral management is seen as a key part of the framework for managing counterparty risk and, in selecting a system, all institutions expect the collateral system to support best practice business procedures across the end to collateral management process. Amongst the breadth of this business process, different institutions will place different emphasis on different parts of the process, often to align with the key drivers for their project. For example, reconciliations, reporting and workflow are three areas commonly focussed upon during a selection from a functional perspective.
Whilst functionality is usually the most important of the elements involved in selecting a collateral system, there are also a number of other factors that are involved in any decision making process.
From a technology perspective, particularly for those organisations aiming for high levels of STP, the flexibility of the systems to integrate with other platforms within the firm’s organisation is often of high importance.
As with any investment, cost is also a selection criteria, but it is not usually the defining one. Most organisations are keen to ensure best fit from both a functional and technical perspective rather than purely looking to choose the lowest cost platform on the market. For most organisations, collateral management is seen as a key part of the process for controlling risk, and, as such, effective controls are not jeopardised to attain a marginally lower cost.
Finally, another key factor, more important than often realised, is who the institution feels most comfortable in working with. When choosing a vendor solution an institution is committing to partnering with the vendor for the medium to long term. A client will often consider what this relationship will be like over this extended period of partnership, considering the vendor’s collateral knowledge, reliability, responsiveness and professionalism. This plays a key part in the decision making process, particularly where, from a functional and technical perspective, systems may be closely matched.
To what extent are regulatory changes and other industry initiatives driving institutions in their collateral system selections?
We are definitely seeing regulatory and other industry developments impacting on collateral management initiatives within institutions, and, in this way, also impacting on collateral management system selections. When institutions consider a vendor solution they expect it to meet all current requirements set out-by regulators. There is also an expectation that the solutions will be developed to be able to deal with the impact of any upcoming regulatory or industry initiatives. In the current environment, clearly there are many evolving industry developments in the market, ranging from electronic messaging to the disputes protocol. One key area of interest for all institutions selecting collateral software is the expected impact of the Central Counterparties (CCPs). The Basel III proposals for strengthening the current capital regime, which are currently under discussion, also touch upon collateral in a number of areas.
Institutions purchasing collateral management software are always very keen to understand how the vendors are developing their software to support such changes, and to ensure that they are aware of the ever-evolving market environment.
How do you see the collateral vendor marketplace evolving over the medium term?
Without a doubt, there will be many changes to the collateral vendor market place over the coming years. Firstly, the host of regulatory changes discussed earlier will dictate much of this development. The way that vendors respond to these will be a key differentiating factor. In addition to these regulatory driven changes, now that many of the operational aspects of collateral management have aligned across the industry, and a high level of efficiency and control has been achieved by many organisations, value added functionality needs to emerge. Examples of such areas, amongst many others, will be collateral optimisation, concentration analysis and monitoring, real time aggregation and management reporting. Support for these areas will be key to enabling collateral management departments to respond to the increased focus on effective counterparty risk management which has become prevalent across the financial industry since the financial crisis. |
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