Collateral Management market context: Need for new efficiencies. EiFR Seminaire Paris, January 22 nd 2014 Diane Nolan Accenture

Collateral Management market context: Need for new efficiencies EiFR Seminaire Paris, January 22 nd 2014 Diane Nolan Accenture

Market context Challenge for Banks Declining revenues & stubborn fixed cost bases are weighing heavily on IB profitability, contributing to single-digit RoE across the industry Securities markets are experiencing a continuing decline in volumes and tightening margins Investment banks are having to adjust to a new reality of tighter regulatory controls and lower volatility The cost of maintaining processes and technology to serve core functions remains stubbornly high, despite targeted efforts to reduce the fixed cost base through traditional means Cost bases continue to be inflated by capital requirements under Basel III/CRD IV and the burden of further regulation, including OTC derivatives reform For some, high funding costs and insufficient returns will force them to exit certain products Other banks will use this inflection to aggressively restructure key businesses, create sustainably lower cost structures and regain competitiveness Copyright 2014 Accenture All rights reserved. 3

Over 30 new regulatory impacts alongside tighter interpretation of existing standards Overview of current regulatory initiatives (international / EU) NOT EXAUSTIVE Bank Regulations Basel III: Hybrid Capital Instruments, Definition of Capital, Capital Requirements, Leverage Ratio, Liquidity Risk Management / Liquidity Standards, Counterparty Credit Risk (CCR), Countercyclical Measures, Systemically Important Financial Institution (SIFI), Living Wills, Single Rule Book Capital Requirements Regulation (CRR) / (CRD IV) Basel III.5: Fundamental Review of the Trading Book EMIR: Central clearing of OTC derivatives and reporting EBA: Stress Tests Dodd Frank: E.g. Volcker Rule, Legal Entity Identifier (LEI), OTC Regulations, Swap Pushout Rule etc BCBS IOSCO (Margin Requirements) as of Sept 2013 Investment Service Regulations MiFID II / MiFIR Markets in Financial Instruments Directive Packaged Retail Investment Products PRIPs UCITS V Undertaking for Collective Investment in Transferable Securities ESMA consultation on the amendment of the UCITS framework (UCITS VI) AIFMD Alternative Investment Fund Managers Directive Regulations on Credit Rating Agencies Prospectus Directive Capital Markets / Settlement / Collaterals / Payments Directive on securities transaction settlement in the EU and Central Securities Depositories (CSDs) Target 2 Securities (T2S) Collateral Central Bank Management (CCBM2) Single Euro Payments Area (SEPA) Migration Regulation of the European Parliament and of the Council on Short Selling and certain aspects of Credit Default Swaps New Market Abuse Directive (MAD) Securities Law Directive (SLD) Accounting / Financial Reporting IFRS 9 Financial Instruments (Replacement of IAS 39) IFRS10 Consolidated Financial Statements IFRS 13 Fair Value Measurement Regulation has become one of the biggest cost contributors within banks today Taxation European Financial Transaction Tax (FTT) FATCA Foreign Account Tax Compliance Act Double Tax Agreements (DTA) Copyright 2014 Accenture All rights reserved. Source: Accenture Research 4

Collateral evolution Unlocking the potential in collateral Key themes of 2011 paper: Paper looked at key challenges of the Collateral market Sized the market as it stood in 2011: Size of collateral market estimated at 10.215 trillion (excluding cash) Outlined the post crisis need for renewal of business model and processing platforms Identified & quantified internal inefficiencies due to organisational and governance challenges Cost of inefficiencies 4 billion annually Identified external inefficiencies, in addition to regulatory pressures, as largely due to market fragmentation and custodian network complexity Copyright 2014 Accenture All rights reserved. 5

Sizing the Collateral Market Total value of securities being used in the collateral market estimated at least 10.215 trillion (excluding cash) Source: Accenture Research Unlocking the potential in collateral Copyright 2014 Accenture All rights reserved. 6

Valuing the inefficiencies Cost of inefficiencies in excess of EUR 4 billion annually INTERNAL EXTERNAL Inability to maximise liquidity, lower the cost of and lengthen tenor of funding Other internal inefficiencies Maintaining excessive levels of collateralisation at Settlement agents Other external inefficiencies EUR 3.80 billions Not quantified EUR 0,40 billion Not quantified Copyright 2014 Accenture All rights reserved. 7

Transparency Optimisation Operating Model Internally driven Impacts Inability Single Collateral Inventory to get full overview of all existing collateral Accurate and frequent information on their entire collateral inventory Issues originating primarily from internal politics and ineffective operating mode Manage Collateral Centrally Inability to manage collateral centrally (or at least across collateral pools Lack of mobility of assets in order to use different asset classes across different business lines Unclear rules in governing the available collateral Optimisation strategies Collateral Value of a security Allocation Methods Collateral Utilisation Strategy Simulation and inventory projection Inability to perform inventory projection Optimal collateral management requires a forward looking approach, meaning, sophisticated forward looking exposure management > collateral management decisions Use the tools that are there more effectively Aligned internal governance Suboptimal internal governance leading to misalignment of objectives The financial crisis worked as a unifier leading to empowerment of the group Treasury and increased focus on liquidity matters Cost control Excessive staff costs die to complexity of processes & redundancy of transactions originated by fragmentation Excessive IT costs due to multiplicity of interfaces with external providers & various internal pools Excessive legal costs due to multiplicity of contracts with multiple providers Internal transfer pricing mechanisms Lack of internal pricing mechanisms Increased scrutiny within universal banks, requirement for collateral systems to be capable of identifying and distinguishing asset classes for the purposes of pricing collateral Sophisticated optimisation engines Unavailability of optimization engines or inability of deploying them Prohibitive investment Changed Treasury Function Emergency of collateral as a front office function, creating greater proximity to Treasury Influence on treasury in overall liquidity management not sufficient and not aligned Copyright 2014 Accenture All rights reserved. 8

Industry Self-Regulation Initiatives Externally driven impacts & Key Trends Electronic Messaging Improving the automation, security, audit trail of collateral calls ISDA Best Practices Paper Feb 2013 Acadiasoft Messaging Platform/ SWIFT FileACT connectivity TriResolve margining/e-messaging Integration of messaging protocols with existing Collateral systems Dispute Resolution Protocol Revised DRP draft Portfolio reconciliation minimum data standards Portfolio reconciliation process definition Standardised CSA Standardised Collateral Agreement to eliminate valuation disputes in multicurrency derivatives trades Dodd-Frank/EMIR Incentives to move OTC Derivative contracts to central clearing via CCPs Establishes minimum capital and initial/variation margin requirements Near-real time reporting on Trade Collateralization status OTC-CCP Client Clearing Offering Collateral Transformation, consolidated margin calls and reporting across cleared/uncleared trades to reduce operational and funding costs Intraday margin calls from CCPs Changes to trade booking models as a result of CCP connectivity & IM/VM Collateral Optimisation Automated Algorithm-based Collateral Allocation considering available assets, obligations, constraints & real-time data Scenario Analysis, Stress Tests Cross-Product Margining Cross-Product/Legal Entity Integrated view of counterparty exposures across products traded Sharing of collateral pools across cleared asset classes Basel III Strengthened capital requirements for counterparty credit exposures arising from derivatives, repo and securities financing Incentives to move OTC contracts to CCP increasing need for liquid, high grade assets Liquirity Risk, LCR, NSFR Incentives to strengthen risk management of counterparty credit exposures Collateral Segregation In the OTC Cleared world clients pushing for full segregation of collateral from that of their clearing brokers/.other clients CCPs trying to differentiate themselves through segregation offerings e.g. Eurex In Bilateral world BCBS/IOSCO and DFA imposing segregation of initial margin at third parties for uncleared swaps Triparty Agents Clearstream Liqiudity Hub /Euroclear Liquidity highway New players with T2S: BONY,JPM, BP2S collateral Collateral as Revenue Generator Gradual transition of some CM-related activities to FO to manage return on risk Speed of credit charge calculation as differentiator to win new business Inclusion of collateral terms/funding P&L to FO trade pricing models to provide more competitive client quotes Global Regulation Market Response/Trends Copyright 2014 Accenture All rights reserved. 9

Focus on Collateral Optimisation Both investment banks and their clients are focusing on optimisation to ensure their collateral assets are deployed efficiently Collateral management is moving further towards the front office: from trade enablement (securing transactions and mitigating risk) to an integral part of front office decision-making (trade pricing, funding decisions) Collateral optimisation is a big part of this change, matching available assets with counterparty exposures and margin requirements in the most efficient way possible The optimal usage of collateral is subjective and will vary from firm to firm, so optimisation strategies need to be tailored according to the profile of the institution if achieved successfully, optimisation is as relevant to the buy-side as it is to investment banks To manage collateral optimisation successfully requires significant investment in technology both in the engine and algorithms used to calculate the optimal placement of collateral, but also in the provision of accurate and granular data across various siloed products and functions to feed these calculations Copyright 2014 Accenture All rights reserved. 11

Some progress on resolving Transparency of Collateral usage but limited progress on real Optimisation Several considerations need to be looked at in order to optimise collateral Collateral Value of a security Existing allocation & exiting inventory (including pooling of collateral) Haircut Concentration limits Operational cost Allocation Method Top up vs Rebalancing Numerical / Linear optimisation Heuristic / Ranking-based models Simulation ability (incoming positions, cost/benefit of rebalancing, What if -analysis) Collateral Utilisation Strategy Avoid fails, e.g. no fails with central banks Maximise liquidity, e.g. get most cash out of the available securities Minimise movements Moment of time during the business day Copyright 2014 Accenture All rights reserved. 12

Since the 2008 crisis, Accenture has launched an annual flagship Capital Markets publication: Accenture s Top 10 Challenges for Investment Banks The publication provides a thought-provoking view on the key operational challenges for investment banks in the year ahead The publication is now entering its 6 th year 2009 2010 2011 2012 2013 2014 Interesting to note that Collateral management has been a constant feature each year...and yet again in 2014 04 TOP10 2014 Challenge 4 - Building Sustainable Funding: Managing collateral & liquidity The demand for high-quality collateral is growing while the supply of eligible securities is shrinking Investment banks must embrace enterprise-wide collateral optimization to reduce their cost of funding and better manage liquidity requirements; High performers are developing new revenue streams with collateral offerings for their clients Copyright 2014 Accenture All rights reserved. 14

Top 10 Challenges for Investment Banks Challenge 4: Building Sustainable Funding: Managing collateral & liquidity 04 Highlights The demand for high-quality collateral is growing while the supply of eligible securities is smaller than ever before; Investment banks must embrace enterprise-wide collateral optimization to reduce their cost of funding and better manage liquidity requirements; Optimization technology, integration with end-to-end processing and enhanced reference data capabilities represent a significant technology investment; High performers are developing new revenue streams with collateral optimization offerings for their clients. Significance as a challenge for 2014 Under Basel III capital requirements, the cost of funding is becoming a closely examined metric; Liquidity Coverage Ratio (LCR) requirements need to be carefully sized and closely managed. For discussion What are the implications of collateral constraints with collateral management and global treasury? How do you see the interaction between these functions (per line of business) How are Basel III requirements (including LCR) in the context of collateral impacting your organization? How effective are Off-the-shelf collateral optimisation solutions available in the marketplace for your needs? Copyright 2014 Accenture All rights reserved. 15

A range of options are available to bring Accenture Capital Markets materials to you Top 10 challenges 1. Printed Papers 2. Microsite 3. Mobile Site All CM publications 4. Cap Mkts ipad App Hard copies available upon request Download PDFs of the papers Watch videos with industry experts Clients can directly request a meeting with the author Access the challenges on the move All current Capital Markets thought leadership. Install the app on your ipad: https://itunes.apple.com/ng/a pp/accenture-library-forfinancial/id506276917 Copyright 2014 Accenture All rights reserved. 16