Navigating Market Dynamism: An Insider’s Perspective on Collateral Management for CCPs

Collateral management—which encompasses managing clearing risk and the identification, securing, valuation and allocation of collateral assets to mitigate counterparty risk—has long been crucial for the smooth functioning of capital markets. However, with recent regulatory reforms pushing central clearing into new asset categories this role has evolved into a more strategically significant function.

Central counterparty clearing houses (CCPs) are at the center of this global transformation in collateral management driven by increased flows, modernization, regulatory reforms and client demands—which we’ve documented in a new whitepaper on the shifting collateral management paradigm.

Although these regulatory reforms have introduced substantial changes and challenges, they are also creating multiple opportunities for CCPs to:

• Reduce operational and systemic risks
• Improve collateral management functions
• Standardize and harmonize collateral workflows
• Offer new services like collateral optimization and tri-party collateral connectivity.

As a CCP operator itself, Nasdaq has unique perspective into the fabric of the financial ecosystem (further informed by our role as a provider of mission-critical technology for CCPs and clearinghouses across the world. As market dynamics shift and new requirements emerge, our view from the inside reveals a number of trends and implications for CCPs. 

Forces of disruption: The good, the bad and the expensive

Market dynamics are accelerating for CCPs, it’s important that they embrace the good, learn from the bad and be cautious with costly aspects of this transformation.

Good: Innovative technologies that make outdated business models obsolete are good types of disruptions from a market perspective by creating room for more efficient and sustainable practices. 

In terms of collateral management, this may refer to everything from process automation and real-time margin insights to asset tokenization that improves collateral mobility and accessibility. These innovations can considerably reduce risk, decrease capital requirements, and lower operational risks for both CCPs and their market participants while opening up new avenues for expansion.

Bad: For CCPs to capitalize on such innovation (e.g., by offering improved clearing and collateral management services, or competing with new entrants) they must address their dependence on legacy systems. Data fragmentation and isolated processes can occur—such as siloed collateral management systems across different business lines, asset types and locations, which all restrict the ability of CCPs to innovate and evolve along with market demands and member firm expectations.

Expensive: Regulatory changes enhance transparency, fairness and mitigate systematic risk, but increased compliance burdens raise costs for many companies, which may even prompt some to exit highly regulated and capital-intensive sectors. In the same vein, the initial investment for new technologies can be significant and the transitional phase can lead to losses. Combine this with other factors like the high cost of capital and the fact legacy systems can be prohibitively expensive to refactor or modernize and the expensive nature of change becomes clear. This is true too for member firms, which must onboard increasing regulation and who will look to infrastructures, including CCPs, for help with managing and mitigating change.

Navigating dynamism with opportunism

While the shifting landscape for CCPs is challenging, it also reveals new business opportunities that CCPs can explore and take advantage of to advance modernized collateral management. This approach can benefit participants and strengthen the efficiency and functioning of capital markets. Here are some scenarios to consider:

Cleared to uncleared

Phase 6 of the UMR came into effect in September 2022 with impacts to non-cleared derivatives.

UMR specifies that counterparties must exchange initial margin against transactions in covered assets once they have exceeded an average aggregate notional amount (AANA) of $8 billion USD or local currency equivalent. The uncleared margin methodology, based on a 10-day VaR, creates more onerous charges on a trade-by-trade basis than the equivalent clearing margin. Given this, firms have ported bilateral portfolios into cleared programs as much as possible.

In 2024, UMR thresholds are being breached for all phases, emphasizing to firms how carefully they need to consider available trading and clearing channels. In summary, the UMR regulation has created a new layer of complexity and cost, which requires a sophisticated and complete optimization of the collateral process to manage funding costs.

Subtext for CCPs

Expanding CCP clearing programs providing an alternative to UMR charges have been welcomed by the market.

Firms in-scope for UMR must carefully consider how to allocate capital and collateral more efficiently while ensuring the proper capacity to navigate increased volume and velocity of transactions that must be managed across new asset classes.

CCPs can help the financial system by offering a cheaper and simpler process with expanded cleared products portfolio-level margining and collateralization across multiple clearing services.

Settlement acceleration

T+1 is live in the United States and other North American markets, while already being the standard in India and China, where T+0 is in force. The arc of market evolution is bent inevitability toward settlement acceleration across the globe. This means that firms investing in these markets will have less time to provide collateral to meet margin and settlement requirements while also managing the operational risk and efficiency of margining across jurisdictions, time zones and evolving regulatory stances.

Subtext for CCPs 

While a shorter settlement cycle helps reduce exposure time of banks to CCPs and systemic risk overall, CCPs need to be mindful of the capabilities required to manage:

• Higher clearing velocity with increases in the frequency and volume of collateral movements, as well as the need for timely collateral valuation and allocation.
• Collateral shortages during periods of market duress and volatility that accompany a reduced time period to source and mobilize collateral from multiple locations and providers.
• Costly reliance on cash or liquid assets if sourcing issues occur.

This means that both banks and CCPs need to have more robust and automated collateral management systems and processes in place for managing the shortened operational timeline. In addition, we foresee an increased use of predictive AI tooling that will aid both CCP and banks in forecasting and optimizing their liquidity needs more efficiently.

Interest rate-margin relationship

High interest rates have emerged in the post-pandemic world, compounding capital allocation challenges and increasing the cost of capital. This results in an even more expensive environment in which to fund margin, especially with cash, while also foisting opportunity costs on members that could otherwise use cash to reinvest.

Subtext for CCPs

Maximizing margin efficiency is crucial for member firms, as it allows them to free up assets and optimize profits. This flexibility can aid in the pursuit of other investment opportunities and alpha generation. CCPs have an opportunity to help members do this by offering collateral and margin optimization services that would reduce the acute impact of continuing high interest rates.

What’s next for CCPs?

There are no signs of market dynamics letting up. As CCPs confront the evolving landscape, they must have a solid foundation from which they can address, mitigate and capitalize on the forces shaping today’s markets. In reality this translates to having modernized technology to keep pace with markets and members—which is a theme we explore more in-depth in the white paper.

Download the whitepaper

Scale, flexibility, resilience and innovation are all in demand in today’s world, and the right technology can help CCPs gain these advantages. CCPs along the maturity spectrum are reviewing their offerings and defining how they can best provide enhanced services for their members. Some may expand the scope of clearing products while others will focus on improving collateral management services by investing in people, processes and technology.

Visit here to learn more about Nasdaq Financial Technology, including our clearing and risk solutions for CCPs and collateral management for capital markets.