Oliver Kirkbright: Could you begin by telling me, from pre-trade to post trade, what steps are you taking to meet your collateral and margin obligations in the most cost-efficient manner?

Mike Duncan: Singlife has established a robust and flexible collateral management infrastructure to ensure accurate measurement, monitoring and management of collateral. We have achieved this by integrating systems, analytics, documentation, instruments, processes, and people to slice and dice from both portfolio and trade level perspectives, to determine ongoing collateral requirements.

Calculating and articulating the true cost of collateral across the lifecycle of a derivative programme is a key objective. Once this has been achieved, it enables you to start optimising collateral costs by selecting the ideal derivative type for your needs and deploying collateral in your preferred format (that is cheapest-to-deliver collateral).

When designing our collateral management infrastructure, we considered all the moving parts and constantly asked questions such as:

• How do new derivative programs impact collateral requirements?
• What derivatives are in use: Exchange Traded Derivatives (ETD) or Over the Counter Derivatives (OTC)?
• If using OTC, are they cleared or uncleared? What are the implications of Segregated Initial Margin (SegIM)?
• What eligible collateral has been agreed in our Credit Support Annexes (CSAs)?
• How will we source and manage collateral, and how do we determine the cheapest-to-deliver collateral?
• When receiving collateral, how do we manage it? When posting collateral, how do we fund it optimally?
• Can we effectively track and monitor collateral? How do we prevent over-collateralisation? Are there valuation disputes with our counterparties?

Answering these questions will help you define and understand your constraints and identify any gaps that need to be addressed.

When dealing with cash for collateral purposes, active cash management must be integrated into your infrastructure. How will you fund or invest cash collateral? Cash drag can be significant if you get this wrong.

OL: Where are the high priority, short term opportunities for optimisation?

MD: Operational alpha is a way to boost performance through active collateral management. Portfolio investment performance can be enhanced by fully costing all components of the derivative life cycle, eliminating unnecessary costs, and proactively deploying related collateral assets to generate additional yield.

Other factors, such as liquidity, risk, and capital management, should be analysed to identify additional opportunities for incremental operational alpha gains.

Quick wins and immediate value can be achieved by focusing on three key areas:

a) Expand the collateral instruments and tools available. This includes repurchase agreements (repo), reverse repos, securities lending (collateral upgrades and downgrades), the range of assets that can be used as collateral (securities, money market funds, etc), Global Master Repurchase Agreements (GMRA), Global Master Securities Lending Agreements (GMSLA) and triparty custody facilities. Your collateral management solutions will be limited if you cannot use these instruments.

b) Simplify where you can. For example, segregate your collateral pool from
underlying investment assets. This makes monitoring and managing collateral independently from the investment portfolio more user-friendly.

c) Think holistically and challenge the status quo. Consider both the investment process and usage of derivatives. Many asset managers have a strong bias for cash instruments and only use derivative instruments for hedging, and less frequently for efficient portfolio management. In cases where cash instruments can be replicated in derivative format, both formats should be costed, modelled, and analysed in detail to determine if there is an advantage in switching. Derivatives are off-balance sheet, so there is no (or minimal upfront) cash outlay compared to the cash equivalent. The upfront cash amount saved can be placed into a combination of high-quality liquid assets (HQLA) and risk assets to cover funding and collateral requirements over the life of the investment/derivative (and can provide enhanced liquidity for your firm). I would only advocate this approach if you have the necessary tools and infrastructure to actively risk manage this strategy on an ongoing basis. It is not a case of set and forget, and it needs to be continually assessed for viability.

I am excited about triparty custody because it offers liquidity enhancements over bilateral custody. The near real-time nature of triparty long boxes allows for same day (T0) liquidity for corporate bonds if used in a repo capacity. Likewise, triparty can be used to make securities lending more user-friendly (risk people also like the risk mitigation benefits from triparty relative to bilateral). The near-real-time management of the collateral pool in the long box allows the use of a broader collateral base (such as high-quality asset-backed securities (ABS) or blue-chip equity, Listed Exchange-Traded Funds (ETFs) etc.) when compared to bilateral custody collateral management.

OL: What are the scalability, infrastructure and systems required for modern, efficient collateral optimisation?

MD: Ideally, one needs a dedicated collateral management system with 100% straight-through processing and minimal (targeting zero) manual workarounds. Spreadsheets limit scalability and add to operational risk and increase costs.

Singlife’s Investment Office implemented BlackRock’s Aladdin front-to-back from a systems perspective, providing a single integrated system (e.g., portfolio management, order management and execution, risk management, settlements, collateral, compliance, performance, etc.) for the Investment Office. It is notable that a single integrated system streamlines and simplifies operational processes significantly (e.g., 100% straight-through processing). Aladdin also provides additional integrated collateral functionality and analytics through its partnership with Cassini.

Singlife is further supported by Citibank, who serves as our middle office and custodian using the same Singlife Aladdin systems and data. This model is new for the asset management industry and is one example of how Singlife does things differently from our peers. The absence of legacy and multiple systems helps us to be more flexible and responsive to change and removes the need for reconciliation across multiple systems. Automation and straight-through processing remove manual processes (mitigating operational risk) and free up our people to think rather than perform manual tasks. Algorithms are deployed to determine the cheapest-to-deliver collateral and rank it in order of priority when posting. Algorithms also identify levels where a portfolio manager needs to step in, otherwise management of collateral is automatic.

Stress testing and modelling of collateral requirements are essential. Forecasting variation and initial margins ahead of the “official” margin calls creates a more proactive rather than reactive approach to collateral management. “What-if” scenarios can help better understand how collateral requirements change and under what conditions. Knowing how market moves impact both the underlying derivatives drive collateral needs and the value of assets used as collateral enables better and decision-making and planning.

The people aspect is often overlooked. It is better to have collateral specialists focus on thinking and making improvements rather than doing mundane and repetitive tasks. This will boost operational alpha.

OL: How can optimisation support innovation and diversification in the collateral market?

MD: Recent changes in the collateral market, such as uncleared margin rules (UMR) and mandated clearing, have created new challenges for the buy-side. These changes have made the market more complex and introduced new collateral management issues.

One of the first challenges for many buy-side firms was meeting the minimum regulatory requirements. Once that was achieved, the next challenge was to leverage the new infrastructure and generate returns from their investments.

The influx of hundreds of new buy-side players into the collateral market has created new opportunities. These new players have different ways of thinking and acting than the banks, and they face different constraints and problems. Additionally, regulatory treatment and constraints vary across the buy-side market. Compounding the need for innovation is the continual pressure to reduce costs and increase alpha.

Securities lending is one example of how innovation could change the collateral market as it is now. Pricing is opaque, with bid-offer spreads wide and variable between banks. This lack of transparency deters participants, volume, and liquidity. Improved pricing transparency would attract more participants and improve liquidity.

Another opportunity for innovation is in direct buy-side to buy-side activity. An intermediary that could remove the need for papering with multiple counterparties could further boost liquidity and narrow spreads.

Overall, the collateral market is ripe for innovation. New technologies and business models have the potential to make the market more efficient, transparent, and accessible for all participants.