By Simon Miller

Derivative traders face a collateral shortfall due to impending regulations in the US and Europe according to a report from TABB Group.

The report, Optimizing Collateral: In search of a margin oasis, found that “collateral scarcity” was becoming the derivative trader’s ‘buzzword’ and as a result traders and clearing organisations have no choice but to quickly become “collateral smart” said author report and TABB principal Alex Tabb.

Tabb warned that the implementation of Dodd Frank and the European Market Infrastructure Regulation brought significant structural changes across the $700trn (£449trn) OTC derivatives market in the process of transitioning from an OTC-based environment to one more electronically traded and centrally cleared.

“These changes include a multi-trillion dollar collateral shortfall with mandatory initial margin levels for cleared and un-cleared swaps, as well as daily variation margin calls,” Tabb said.

Market participants assume that their brokers and dealers will assist with the multi-trillion dollar shortfall through collateral transformation services.

However, according to Tabb, “this isn’t going to happen” because many large firms don’t want to take the balance sheet hit that comes with long-term transformation deals.

Central counterparty clearinghouses (CCPs), for example, say they recognise that they will need to offer innovated services to their clients in order to sustain their market share and trading activities, including cross-product netting opportunities reducing margin requirements. “CCPs that offer the most offsets will garner the most business,” says Tabb.

For swaps dealers and end users, Tabb said there was a need to invest in technology, managing the complexities arising from mandatory initial margin and multiple daily variation margin calls, ensuring that they can manage this complicated process in a timely, cost-efficient manner

From a technological standpoint, collateral optimisation required cutting-edge technology to identify, prioritise and deliver the lowest cost, mutually acceptable form of collateral across an entire firm. While from an organisational standpoint, it required process harmonisation and improvement across organisational elements that have existed in operationally- and geographically-separated silos that for years showed minimal attention to collateral management, according to the report.

Tabb commented: “Those days are over. Firms that invest in technology and services should be able to weather the approaching storm and sustain their activities. But those that don’t will be hard pressed to compete.”

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