Scaling Collateral Management for Business Growth
May 28, 2024
Read Time: 7 minutes
Treasury Suite
Ashley BellVice President, Financial Operations
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In the world of hedge funds, where leverage is a precision tool, collateral management can get complex. The larger a firm grows, the more there is to manage in terms of trading volumes, business lines, legal entities, regulatory requirements, margin agreements, schedules, and more.
At the same time, there’s only so much capacity an internal treasury and operations team can provide without adding headcount, and as a result, using or optimizing technology is imperative to create scale and continued growth.
Here at Arcesium, we understand these challenges and work with some of the industry’s most sophisticated hedge funds to equip them with the tools, technology, and services for better collateral management. To help you navigate the journey, we’ve outlined a series of considerations and strategies to take your firm’s collateral management process to the next level.
Collateral has always served an important role in financial markets, especially for hedge funds. More recently, however, collateral management has taken on a new and increased focus. Whether it be from the global financial crisis in 2008 to the market volatility in 2020 driven by the pandemic, or the current interest rate and regulatory environment, a resilient collateral management process could be a difference between a firm’s long-term success and growth or not.
For these reasons and more, hedge funds should take these events not only as a wake-up call but also as a call to action to optimize their current collateral management process for the future. With advances in technology, and a systematic approach, collateral management can transform from a compliance or administrative exercise to a strategic opportunity with the potential to improve capital efficiency and enhance returns.
With technology applied to collateral management, hedge funds can get a centralized location to store, view, and track all their margin agreements, requirements, calculations, and activities in one place. Instead of using a patchwork of tools, manual processes, or simply relying on counterparties, technology can also be used to support a more holistic process whereby you can compare internally calculated exposure, replicated margin requirements, and corresponding collateral movements with external counterparty figures to assess the validity of a margin call from the broker, or initiate a margin pull. With a system in place, this enables a firm to:
Lastly, collateral management technology can also lay the groundwork for broader digital transformation enhancements, whereby information can flow seamlessly to other operational areas of the firm and create more efficient, comprehensive workflows without redundant data entry to ensure accurate daily cash figures in the general ledger.
One of the biggest opportunities for a collateral management system comes through the ability to integrate and consolidate information surrounding different product types, agreements, exposures, and counterparties to a single or centralized view. Too often, all these pieces and data points are fragmented and filled with manual processes across different pockets of an organization instead of being supported by a streamlined workflow.
Further compounding the challenge is that for many large hedge funds, the technology available for collateral management can be notoriously compartmentalized as tools often do not have margining capabilities to cover all asset classes. This leads firms to partner with multiple vendors, creating additional bottlenecks in operations, reporting, and analysis to further limit efficiency, as well as increase exposure to sensitive data.
Instead of turning to multiple individual tools, implementing a centralized system with an overarching data strategy opens the door for a host of new and meaningful opportunities, including:
In a higher interest rate environment, many firms are looking for better cash management as well as opportunities to optimize or pull back excess margin. However, this can be a cumbersome operational burden without a centralized, robust view of data or integrated technology tools.
By implementing better data practices and technology, Treasurers can more efficiently understand risk, exposure, and cash availability. Technology tools and services can be used to help identify additional liquidity pools with which to invest through different channels such as money market funds (MMFs) or Treasury bills, or even just increase buying power for potentially more profitable trading opportunities.
While understanding the role of technology and its benefits, how can firms begin to improve upon their current process, or even get started with a new solution? Wherever you are in your journey, here are a few key factors to consider:
As touched upon above, reimagining a collateral management operation can also boil down to more than a technology decision. Sometimes the most important technology decision you can make is who you’ll be working with and the expertise they can bring alongside a system. That’s why here at Arcesium, we can complement our comprehensive technology solutions with experienced accounting, operations, treasury, and data management professionals who can operate as an extension to your firm.
With comprehensive and deep experience working with complex margin agreements, our team can help manage your exposure, supervise counterparties, unlock excess capital, and evaluate yield enhancement opportunities. Across our clients, equipped with the powerful combination of our team’s services and technology, we’ve helped to claw back an average of approximately $6.5 billion per year in erroneously called margin.
As market dynamics continue to grow more complex, collateral management becomes more important, and the decision to implement new tools and technology within a firm’s operation can be pivotal for future success and resiliency. Yet, all too often, firms find themselves taking stock of their internal systems and processes reactively, driven by the urgency of a market event or regulatory mandate. In times of market stress, hedge funds could find themselves experiencing extraordinary margin spikes, and initiating a thoughtful review of systems infrastructure is going to be inherently more challenging while in the throes of a crisis.
Second, any change to a hedge fund’s operating technology is a big investment in terms of time and resources. You do not simply want to invest in narrow solutions for immediate needs only to see a far more nuanced situation emerge where a different set of sophisticated tools and services are required in two years. Instead, consider both where you are in your current life cycle and the firm’s longer-term plan, especially as the hedge fund market is projected to grow.1 As requirements may naturally change over time, one solution is to select a vendor that’s nimble and robust to grow with you along the way in addition to meeting your current needs.
By engaging in a strategic exercise before challenges emerge, firms can improve their preparedness as well as have the advantage of time to align their collateral management capabilities and infrastructure to specific business and operational needs. Ultimately, by embracing a more proactive approach, firms may find they’re better positioned for long-term success in an ever-evolving financial landscape.
Sources:
1 Hedge fund market to reach $13tn globally by 2032, Hedgeweek, March 21, 2024
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