The Jacob Fleming Conference Collateral Management on 18-19 October in Amsterdam provided a great opportunity to discuss the hottest issues related to the topic. Danny Peeters from KBC was one of the top speakers at the conference who answered our questions focusing on reconciliation together with his colleague Philip Brackx.
Danny Peeters is the responsible manager of the Collateral Management Desk of KBC bank. In that role he is the moving force of the continuous growth that the collateral management activities of KBC have shown during recent years.
His commitment to Collateral Management goes further than KBC, as he is actively involved via different initiatives, e.g. participation to the ISDA working groups on CM, to raise the level of professionalism and innovation of the Collateral Management practices.
Philip Brackx is responsible for the business development and sales activities of the Collateral Management Desk of KBC Bank. In that role he is searching the market for financial institutions which are interested in cooperation with KBC Bank on the field of Collateral Management.
Next to that he is also keeping track with the evolutions in Collateral Management to guarantee that KBC, as Collateral Management Services provider, stays on top with the latest developments.
Why is portfolio reconciliation necessary? What are the major issues in portfolio reconciliation? How can the reconciliation process be improved?
Portfolio reconciliation should provide a means of ensuring that parties’ books and records remain synchronized over the lifetime of the portfolio, and that effects of trade events, such as novations, amendments and other activities, are accurately captured.
Why reconcile portfolios? The following figure gives an overview of the reasons why we are convinced that Portfolio Reconciliation is key part of the collateralization process:
Source: ISDA Collateral Framework paper on ‘Recommended Practices for Portfolio Reconciliation’
Portfolio reconciliation is interoperable with, but not duplicative of other processes such as auto-matching or affirmation. As portfolio reconciliation allows two parties to agree on the number and exposure of the existing trades and detect any missing transactions or errors. By doing so at an early stage, potentially large losses will be avoided in the future and timeframes for the resolution of any discrepancies can be tightened.
Linked to the daily collateral management operations, this enhanced ‘quality of the portfolios’ reduces the frequency of collateral disputes and also the under- or over –collateralization, or shortens at least the occurrence thereof.
A selection of the major issues on portfolio reconciliation is mentioned in the next figures:
Source: ISDA Collateral Framework paper on ‘Recommended Practices for Portfolio Reconciliation’
A ‘Strategic Reconciliation Model’ is needed if the players in the collateral management world want to overcome the aforementioned issues. A proposed model, cf. ISDA Collateral Framework Group, is based on four key pillars; commitment within the organizations and the industry, a bilateral approach in understanding and solving any issues and the necessary technological support to achieve a cost effective / efficient model as possible;
How can Collateral Management add value to the business? What are the main objectives of Collateral Management?
Mitigating credit risk is still the main driver for collateralization.
If you are a financial institution, then you can achieve regulatory capital savings through the collateralization of your transactions (cf. Basle II regulation).
Besides this, collateralized trading also increases your business opportunities. In fact you may be allowed to trade more exotic products of longer duration with diverse counterparts within the entire rating spectrum which would otherwise be prohibited because of the bank's credit policy.
Having a collateral contract in place helps you to benefit from more competitive prices in your transactions, since collateralization reduces the need for capital support, read the cost of capital. In reverse, it allows dealers to offer more attractive prices.
And finally, our recent contacts with smaller Tier II banks revealed that some of them are strongly urged by their Tier I counterparts to enter into collateral arrangements, as these Tier I banks are, in accordance with the Basle II regulations, severely punished for any unsecured exposure with lower rated financial counterparties.
What are the benefits of outsourcing Collateral Management services?
A key question is whether, as a smaller- to mid-sized bank, you want to do the collateral management yourself and how to organize it.
Using Excel is no longer acceptable, taking into account the accompanying operational risk. The real choices are developing and building a full system in-house or working with an application service provider (ASP).
If collateral management is not considered as a core activity, then outsourcing is the most economically beneficial solution. As by outsourcing the financial institution can immediately cash in the advantages of collateralization and not have to bear the substantial investments (read cost) to build an integrated straight-through collateral management processing system.
KBC Bank positions itself as outsourcing CM services provider, and primarily targets those banks that do have the internal resources to focus on this area or do not have the critical mass to make the in-house development or purchase of a collateral management solution economically justifiable.
What are the latest trends in Collateral Management?
The latest hot topic in Collateral Management is 'Portfolio Reconciliation'.
Continuously there is also the drive for more optimization:
- of the collateral management operations, through more standardization and automation, and,
- of the usage of cash / securities collateral itself, through re-use and re-hypothecation.
What were the key learning points for you from the event? How did you like the event?
For the Collateral Management Community it is a welcome initiative to organize these conferences, which are a forum to discuss the Collateral Management operations and best practices of a variety of market participants.
As a participant it offers you also the possibility to benchmark your own collateral operations and it is a great opportunity to build an informal network of collateral specialists or collateral users.
November 2007 in Amsterdam
