A more proactive approach to sourcing eligible assets could limit cost impact of new regulations

LONDON, December 13, 2012 — A new paper published by BNY Mellon, the global leader in investment management and investment services, in association with specialist banking consultants Rule Financial, examines the profound impact that the fundamental post-crisis regulatory reform of the OTC derivatives markets will have on all users of those instruments.

The paper, entitled 'To Clear or not to Clear…Collateral is the question',  looks at what avenues are open to institutional investors who – with the advent of the Dodd-Frank Act, EMIR and other equivalent rules – face substantial business and operational challenges around executing, clearing, collateralising and reporting OTC derivatives trades.

Banks, facing comparable challenges, are investing in collateral optimisation projects that seek to maximise the efficiency with which assets are sourced from across their firm to meet collateral obligations.

While the applicability of collateral optimisation can be considered to be diminished for institutional investors because of the fragmentation of assets under management into discrete portfolios, the paper concludes that a more proactive approach to sourcing eligible assets is appropriate when it comes to limiting the cost impact of the changing collateral burden precipitated by new regulations.

The paper outlines five additional steps that – assuming regulatory exposure is understood – that portfolio managers may take to achieve the goal of cost limitation:

• Review OTC derivatives strategy to establish which cleared contracts will be used.
• Model the initial margin requirement of the current or projected OTC derivatives portfolio.
• Identify all incremental costs under the new rules.
• Consider strategic and tactical changes to the investment process.
• Evaluate service offerings that can mitigate costs.

Accordingly, as a matter of priority institutional investors should be engaging with their clearing brokers and custodians to evaluate alternative sources of collateral – and, where necessary, agree on changes to investment mandates and counterparty documentation to work towards ensuring that all potential benefits are realised.

Nadine Chakar, executive vice-president for Global Collateral Services at BNY Mellon, said: "There is an opportunity here for those institutional investors that are natural holders of CCP-eligible collateral, and these assets will be subject to intense demand from banks and other institutional investors to cover margin. The ability to lend such assets, subject of course to adequate risk controls, could therefore be a means of offsetting some of the costs of compliance with the new rules as well as augmenting depressed yields."

Jonathan Philp, specialist in OTC clearing & collateral management at Rule Financial, said: "One impact from a portfolio management perspective is the increase in collateral that must be provided to support OTC derivatives activity, whether cleared or not. The danger is that the perceived benefits of central clearing are overwhelmed by the unintended consequence of the costs of compliance being passed through to the policy holder and pension scheme member, for example, whether in the form of constrained, sub-optimal portfolio decisions or the direct costs of adapting to the new market structure."

A copy of the paper can be found at http://www.bnymellon.com/foresight/foresight.cfm?id=cs

Global Collateral Services offers a comprehensive suite of capabilities to help our clients address their collateral, liquidity and securities financing needs. As they face evolving global regulations and rapidly changing market requirements, clients can leverage BNY Mellon's products and services to better manage counterparty and market risk in their collateral transactions, engage in more investment opportunities to help maximize their investment returns and access new financing alternatives.  BNY Mellon currently services $2 trillion in global collateral (including tri-party repo collateral worldwide) and approximately $100 billion in assets through its Liquidity DIRECT(SM) investment portal, and operates one of the industry's largest securities lending programs, with $3 trillion in lendable assets.

BNY Mellon is a global financial services company focused on helping clients manage and service their financial assets, operating in 36 countries and serving more than 100 markets. BNY Mellon is a leading provider of financial services for institutions, corporations and high-net-worth individuals, offering superior investment management and investment services through a worldwide client-focused team. It has $27.9 trillion in assets under custody and administration and $1.4 trillion in assets under management, services $11.6 trillion in outstanding debt and processes global payments averaging $1.4 trillion per day. BNY Mellon is the corporate brand of The Bank of New York Mellon Corporation (NYSE: BK). Additional information is available on www.bnymellon.com or follow us on Twitter @BNYMellon.

Rule Financial is a leading independent provider of business and IT services, employing over 500 people in the UK, the USA, Canada, Spain and Poland. Our specialists work alongside their counterparts at the world's leading investment banks, exchanges, central counterparties, institutional investors and hedge funds, helping to lower costs, improve productivity and extract the maximum value from IT investments. We offer our clients end-to-end solutions that solve their complex business and IT issues. Our specialists have a deep understanding of the increasing regulatory pressures faced by financial institutions and a number of our recent engagements have included strategic consultancy and solution delivery around OTC derivatives regulation and the implications of central clearing on integrated systems and collateral management. We cover all aspects of advisory, execution and support services. Our domain specialisms include Securities Finance, Prime Services, Risk Management, Trading, Legal & Compliance and Operations. Our delivery specialisms include advisory and execution services in system development, user-centric design, software development, integration, testing, on-going support and IT outsourcing.

Additional information available on www.rulefinancial.com or follow us on Twitter @rulefinancial.

This press release is issued by The Bank of New York Mellon to members of the financial press and media. All information and figures source BNY Mellon unless otherwise stated as at September 30, 2012. The Bank of New York Mellon, London Branch, registered in England and Wales with FC005522 and BR000818
Branch office: One Canada Square, London E14 5AL. Authorised and regulated in the UK by the Financial Services Authority.