Last week, I shared some of Dodd-Frank Act’s implications on banks. While the final details are still being determined, now is the time for banks to engage in the transformation of their independent amount (IA) collateral management process and better position themselves to answer the new collateral management paradigm.
Banks and other swap market participants should start preparing for IA compliance now by taking the following steps:
- Understand the trades and counterparties in scope for Dodd-Frank IA. Banks should perform a detailed analysis of their portfolios to clearly identify the type and volume of trades subject to IA posting. This analysis needs to be coupled with an assessment of counterparties. The key outcome of such analysis is for banks to strategically redefine their activities with certain categories of counterparties. Banks need to find the right balance between the revenue generated from their swap portfolios against the cost of the added amount of collateral required.
- Begin repapering of credit support agreements to include appropriate IA terms and conditions. Banks will need to amend and/or draft new Credit Support Annexes. As a result, institutions should plan for a significant repapering effort and build additional capacity from the firm’s infrastructure and legal staff.
- Engage in developing a risk-based IA calculation model. Swap dealers and market participants will need to implement risk-based IA calculation to reduce collateral costs. A phased approach to building and obtaining regulatory approval should begin now. Banks should start assessing their quantitative and technology capabilities to build internal models. They then should start engaging in prototype development of an IA calculation model and begin developing a model approval framework, including a plan for submitting the IA calculation prototype to regulators.
- Develop a collateral optimization program. With regulators proposing only high quality collateral to be pledged as IA, along with its segregation into separate accounts, financial institutions will need to start a comprehensive collateral inventory management and optimization program. To do this, it will be essential for banks to possess a firm-wide method of managing collateral and view and proactively manage collateral inventory and obligations across product and business lines.
Accenture finds that most banks have elements in place to begin a successful transformation in response to the IA challenge, but they require support to link these elements together to create a comprehensive approach.