A ‘Smart’ Approach to Blockchain for Collateral Management: Bringing Banks and Blockchain Together
Authored by: Selwyn Halbertsma, Director - Consulting Practice, Business and Management Consultancy, Synechron
A blockchain solution for OTC derivatives margin calls could automate collateral management and help banks better manage liquidity risk, but collateral managers need to understand the technology to create that killer app.
Starting 2016, financial institutions faced regulations that increased their margin requirements for uncleared derivatives. This sounds complex, but the bottom line is the regulation creates an ongoing need for consolidated margin call data (which varies across brokers) to better manage how much cash reserve is needed to support their business (collateral).
With the DTCC estimating margin call activity could increase by 1,000% due to these requirements, the financial impact to banks and investors due to receive a margin call when their investment decreases past a certain point could be significant.
In fact, according to the DTCC, 15% of collateral is idle and costing banks an estimated $4.5B annually. A separate study from Oliver Wyman conducted for SWIFT estimated settlement/custody/collateral management to be $40-45 billion and $20-25 billion for post-trade data and analytics, which is large sum for any bank.
Blockchain can reduce that spend by bringing together three key features: distributed ledger technology (DLT), smart contract functionality and payments to create an application that would automate margin call management.
What is blockchain?
Blockchain is causing a lot of buzz within financial services, since bitcoin, the first blockchain application for digital payments emerged powered by the Blockchain computing architecture. However, since then, several other Blockchain infrastructure providers have emerged: Ethereum, Hyperledger, Ripple, Chain, to name a few. Anyone in a collateral management role thinking about using blockchain will need to understand the difference between a public blockchain (anyone can join the network and see the data) and a private, permissioned blockchain (the network participants determine who can access the network and view data). Most financial services applications, like margin calls and collateral management will require a private permissioned blockchain infrastructure be used, and while not all offer this functionality natively, it can be more easily developed in an Ethereum or Hyperledger environment.