Facing increased regulatory oversight, more banks are opting for an integrated collateral management system that facilitates collateral optimization in coordination with central clearing counterparties (CCPs).

1. Collateral Management in Focus
At a time when collateral is getting scarce and markets are volatile,
banks need to adopt better tools and technology to manage the risks on
their assets and optimize allocation of assets across counterparties in
the most efficient way possible.
Executive Summary
The recent economic crisis, especially the
sovereign debt crisis in Europe, has swung the
spotlight onto credit risk mitigation mechanisms
including collateral management. New regulations
such as Dodd-Frank, EMIR and BASEL III demand
better management of liquidity and credit risk.
Financial service organizations are therefore
realizing the need for efficient collateral optimi-
zation platforms as well as the need for collateral
management across diverse asset classes.
In this paper, we examine the regulatory and
business forces shaping the securities industry,
the resulting impact on collateral management
and how firms need to respond to new technology
needs in the wake of these changes (see Figure 1).
Drivers of Change
The Dodd-Frank Act in the U.S. and the EMIR rules
in Europe are at various stages of implementation
but have already begun impacting the post trade
industry, particularly in collateral management.
Moreover, financial institutions are realizing that
collateral optimization across multiple product
lines and geographies will result in significant
cost savings.
Introduction of Central Counterparties
The Dodd-Frank Act mandates that all standard-
ized derivatives be cleared via a central clearing
counterparty (CCP). The European Securities and
Markets Authority (ESMA) requires OTC derivative
trades to be cleared by an authorized CCP. Certain
nonstandard OTC trades that are unsuitable for
clearing by a CCP are subject to stringent internal
governance, audit checks, higher capital require-
ments and operational risk management require-
ments for collateral valuation, reconciliation and
dispute resolution.
Margin Requirements
CCPs are now enforcing stringent initial margin
requirements and clearly defining the acceptable
security profiles. In addition, the cost of sourcing
collateral assets for initial margin is higher if the
margins are segregated rather than being paid on
an omnibus basis.
Liquidity and Quality of Collateral
Capital adequacy requirements under the Basel III
accord have limited banks’ ability to deploy liquid
assets. CCP margin mandates have aggravated the
liquidity crunch for quality collateral. Most CCPs
restrict acceptable assets to cash or high-grade
bonds such as U.S. Treasuries or EU bonds.
• Cognizant 20-20 Insights
cognizant 20-20 insights | june 2013

2. 2
Stringent Risk Management
In the wake of the new regulations, financial insti-
tutions need to strengthen their risk coverage
for the capital held by maintaining more granular
data with historical trends for a detailed view of
risk across the enterprise. They need to enhance
their internal rating-based models for credit
risk management to determine different risk
measures such as probability of default (PD),
exposure at default (EAD) and loss given default
(LGD). Moreover, a large institutional counter-
party may need to deal with multiple CCPs, which
would require optimal allocation of its portfolio to
meet individual CCP requirements.
Banks will need to consider the potential credit
risk losses due to deterioration of credit quality
of the counterparties (known as credit value
adjustment) in counterparty credit risk (CCR) cal-
culations and perform stress testing and scenario
analysis to identify potential risk factors. However,
an overly conservative approach to risk-weighted
assets valuations would decrease the capital for
the front office.
Banks are looking at firm-wide collateral holdings
across all asset classes and the firm’s operating
geographies as inputs for calculating credit
exposure and counterparty risk calculations.
Mandatory Reporting
In the G20 leadership summit in 2009, it was
agreed that all standardized OTC derivative
contracts should be reported to trade reposito-
ries (known as the swap data repository in the
U.S.). The trade repositories will be the authorita-
tive source of OTC derivative trade information.
EMIR requires that all EU trade repositories must
register with ESMA while Dodd-Frank mandates
that all U.S. trade repositories register with CFTC.
Non-EU or non-U.S. trade repositories also need
to be recognized by ESMA or CFTC to enable trade
with EU- or U.S.-based counterparties. Regulators
will have access to these repositories, allowing
them a better overview of trade positions and
helping them to detect any potential problems
such as accumulation of risk for a specific coun-
terparty. In addition, trade repositories will have
to publish aggregate positions by each asset class
to give all market participants a clearer view of
the OTC derivatives market. New legal documen-
tation will be introduced in addition to current
ISDA agreements.
New Players and Revenue Opportunities
Nontraditional participants such as monetary
authorities and government agencies are also
collateralizing their repo trades and derivative
transactions with pension funds as the
underlying assets. CCPs now need to manage an
increased volume of collateral due to the influx
of OTC derivative trades. These new players seek
assistance from agents offering tri-party collateral
management services to manage operational and
counterparty risk at an enterprise level. Large
custodians such as BNY Mellon and J.P. Morgan
hold trillions of dollars of assets in custody. They
are positioning themselves to set up an efficient
supply and demand matching of collaterals by
integrating collateral management services
cognizant 20-20 insights
Figure 1
Evolving Collateral Management Landscape
Introduction of CCPs
Margin Requirements
Risk Management
Mandatory Reporting
Collateral “Crunch”
Cross-Border CM
New Types of Collateral
STP of Collateral
Transactions
Efficient Security Movements
Cross-Border Links
Dispute Resolution System
New Players
Dispute Management
Drivers of Change Impact on CM Technology Adaptation
Liquidity and Quality
of Collateral
Focus on Collateral
Optimization
Less Collateral
Re-hypothecation
Real-Time Valuation
and Reporting
Integrated Collateral
Management
Reporting
Infrastructure Upgrade
Collateral
Optimization Engine

3. across multiple asset classes. Nonbanking firms
such as clearing agencies and securities deposi-
tories are also looking to capitalize on this oppor-
tunity. Euroclear is creating a collateral highway
— a first-of-its-kind international market infra-
structure to mobilize collateral where needed.
Impact on Collateral Management
The macro-trends in the securities market
described in the previous section have begun
to have a significant impact on the collateral
management industry.
Collateral “Crunch”
The collateral process involving CCPs has created
a larger cost burden for financial firms. Working
with a CCP involves direct costs such as system
and operational changes, as well as paying
membership fees for being a clearing member.
Moreover, the initial margins on transactions with
CCPs are higher than those of OTC transactions.
One CCP does not cover all asset classes/geogra-
phies; hence, a large financial institution has to
enter into agreements with multiple CCPs, which
increases the cost.
Finally, the new capital adequacy mandates for
banks mean that they need to maintain a larger
share of liquid assets in their inventory, thus
reducing the supply and increasing the price of
quality assets.
The pressure on banks to find this extra collateral,
combined with demand from clearing houses
for only the best collateral, is giving rise to a
“collateral crunch.”
Banks have devised several ways to make the best
use of the collateral available on their balance
sheets:
• Cross-border collateral management: For mul-
tinational banks that hold assets across several
markets, we have noted an increased adoption
of cross-border collateral management. In this
model, idle assets in one country (market) can
be used as collateral in another country. In Eu-
rope, this is being enabled by the correspondent
central banking model (CCBM), which allows
a counterparty to use eligible assets issued in
other Eurozone countries as collateral.
• New collateral types: Another trend is the in-
troduction of new asset classes such as com-
modities and letters of credit as collateral. Al-
though this results in a larger pool of assets,
new concepts and guidelines are required to
determine eligibility, margin and haircuts appli-
cable for these asset classes.
• Collateral optimization: With the increased
demand for safe and high-quality assets, collat-
eral optimization is gaining momentum to en-
sure assets are deployed as efficiently as pos-
sible. In the current economic scenario, optimal
allocation of collateral can lead to significant
savings even after accounting for the cost of
an advanced optimization engine.
However, collateral optimization is easier
said than done. The collateral giver and the
collateral taker agree to a security eligibility
profile for their transactions based on various
criteria such as haircut, security rating, issuer
type, market type (e.g., first domestic then
international) and transaction amount. Some
of the criteria are mandatory while some
are optional but are considered in order of
preference. Complex algorithms are required to
determine optimal securities from a collateral
pool that satisfy the mandatory criteria.
Maintenance of the collateral pool is vital for
optimal allocations. The long trail of collateral
movements due to reuse needs to be tracked.
Collateral receivers have increasingly taken
to changing the eligibility criteria frequently,
resulting in additional responsibility for the
collateral giver to reallocate using optimized
techniques. The optimization process must be
run multiple times in a business day to take
into account the most up-to-date securities
positions. After the closure of a business day, a
complete reallocation of securities is required
for all the open trades. This removes any inef-
ficiency in collateral allocation due to the rapid
and frequent nature of trades.
• Reduced collateral re-hypothecation: Post
the collapse of Lehman Brothers in 2008, the
re-hypothecation of collateral has dipped (see
Figure 2).
Clients have become more cautious and are
including clauses in the contract to limit the
amount of collateral that can be reused. Also,
to meet the liquidity standards participants are
trying to hold more high-quality liquid assets
as part of the on-balance-sheet assets. As only
off-balance-sheet collateral can be reused, the
volume of collateral being reused is lessening.
According to a working paper published in
2010 by the International Monetary Fund,1
the collateral received that could be reused
by the seven largest U.S. broker-dealers had
decreased from about $4.5 trillion at end-2007
to $2.1 trillion by end-2009.
3cognizant 20-20 insights

4. cognizant 20-20 insights 4
Need for Real-Time Valuations and Reporting
Collateral valuation is moving toward intraday
and real-time valuation from the tradition-
al end-of-day/weekly valuation. Up-to-date
valuations being factored into pricing and trading
decisions will lead to high-frequency exposure
management. In order to support this, the
reporting needs to be real time as well. Moreover,
the extent of reporting is wider nowadays,
covering collateral valuation, portfolio reconcili-
ation, forecasting, exposure calculation, margin
calls, intraday liquidity and dispute resolution.
Dispute Management
In the current regulatory maze, firms face a sig-
nificant operational risk from the time lost in
resolving disputes. Counterparties are increas-
ingly agreeing to a transparent dispute resolution
protocol in their contract and adopting active
portfolio reconciliation to minimize disputes. The
ISDA master agreement is the most commonly
used contract for OTC derivatives. It provides a
standard protocol that sets out strict guidelines
and timetables for dispute resolution. For
example, it requires that in the case of a dispute
the undisputed collateral amount (the lower value
of both counterparties’ estimates) must at least
be moved immediately. Dispute detection and its
timely resolution is becoming an important part
of a collateral management setup.
Adapting the Technology Platform
Technology and automation are critical to keep
pace with the changes in regulatory and client
demands. We see firms investing in technology
solutions to bolster straight-through processing
of trades by embracing a standard messaging
channel with external entities such as settlement
systems, CCPs and depositories. An integrated
view of collateral across asset classes, currency
markets and geography and a rule-based
collateral optimization engine are becoming
crucial needs. Also, frequent changes in margin
requirements and the increased regulatory focus
on transparency have resulted in the demand for
a dispute resolution system (DRS) for collateral
management trades. The major areas to watch
in the evolution of collateral management
technology are discussed below. Figure 3 below
represents a future state collateral management
platform highlighting the probable impacted
areas.
Increase Efficiency Using STP model
Firms should automate components of the
collateral management lifecycle ranging from
margin calculation to the settlement of collateral
between counterparties.
Currently, the low penetration of straight-
through processing (STP) is due to the complexity
in the processes involved — from origination
to settlement. STP can be achieved by using
automated collateral transaction processing and
through the use of global and common standards
such as SWIFT.
Firms attempting an STP model must consider
the following:
Source: Company Reports, IMF Staff calculations.
Figure 2
Collateral Received that Is Permitted to be Pledged at Large U.S. Banks
(November 2007–December 2009; in billions of U.S. dollars)
0
100
200
300
400
500
600
700
800
900
1000
Bear Stearns Lehman Goldman
Sachs
JP Morgan CitgroupMerrill/BoA
Rehypothecation Declined During the Recent Crisis
Nov-07 Nov-08 Sep-09 Dec-09
Morgan
Stanley

5. cognizant 20-20 insights 5
• Standardized electronic messaging: Instead
of phone/fax/e-mail channels, the use of
secured and fast electronic messaging can
transform the way margin calls are managed.
It can automate the settlement process,
reducing risk and freeing up time to focus on
failures and breaks identified in a transac-
tion. This increases the operational efficiency
of executing collateral management transac-
tions since electronic messaging makes the
exchange of information transparent and less
ambiguous between the counterparties.
• Automated margin calculation/validation
and settlement: Each margin call should be
subject to predefined STP margin rules. The
counterparty can agree to or dispute the
margin call and provide its response using
electronic messaging.
• Optimized collateral allocation: An automated
and analytic engine is required, which allocates
collateral optimally as discussed in the “Impact
on Collateral Management” section earlier in
this paper.
Reducing Credit Exposure (Sequencing
of Security Movements)
A proper synchronization of security movements
can significantly reduce the credit exposure. The
system should make the best effort to execute
a security movement that returns cash/credit
back to the collateral giver before processing a
security movement that draws the giver’s credit
line. This helps reduce the overall credit exposure.
Integrated Collateral Management
For historical reasons, collateral management has
been perceived as a back-office activity with the
Source: Cognizant
Figure 3
Future State Collateral Management Platform
Legend
Impacted process
(Changed/New)
Repo Treasury Derivatives
Message Gateway
Messaging & Validation Layer
MessagingLayer
Determine Available Securities
Settlement Instructions
Reporting layer
StandardMessaging&validationlayer
Security Movements
Asset Positions
CCP’s
Securities
Lending
Collateral
Substitution
Change in
Txn amount
Integrated Collateral Allocation Rules Engine
(across products and collateral movement triggers)
Transaction
Start/End
Priority
Order
Collateral
Allocation
Margin
Calculation
Fail Curing
Collateral
Reuse
Generate Settlement
Instructions
Synchronization of
Security Movements
Reporting Module
• Margin Report
• Exceptions Report
• Portfolio Reconciliation Report
• Internal Reports
Dispute Management System
• Portfolio Reconciliation System
• Dispute Resolution
• Real-time View of Margin Calls
• Stand-alone Modules,
Easily Integrated
Contract Information
Settlement
Messages
(Real time)
Settlement
System
Depository/
Cross-Border Link
Eligibility
Criteria
Online
Reports
Mobile
Devices
Third- Party
Reports
Report Data
Feeds
Real-time
Asset
Positions
Reference Data
• Security Price
• Corporate Actions
• Counterparty Data
• Credit Rating

6. cognizant 20-20 insights 6
focus on risk management. It developed in silos at
most banks with separate teams for repos, securi-
ties lending, derivatives and funds (see Figure 4).
Hence, there is limited integration between
collateral management functions within a bank,
leading to multiple systems dealing with collateral
trades, a fragmented view of the asset inventory
and needless manual intervention.
An integrated collateral management solution
can enable the firm to view and manage collateral
inventory and obligations on an enterprise-wide
basis and across product lines — and possibly
across business lines and geographies — with
increased efficiency. Removing internal fragmen-
tation can also help the participants reduce oper-
ational costs by virtue of better utilization of the
collateral available. This reduces dependency on
market borrowings. Firms attempting consolida-
tion must consider the following:
• Ensure consistency, standardization of data
and infrastructure across the product lines.
• Harmonize the operating model and best
practices across product groups.
• Ensure local regulation and tax structure are
followed if assets are spread across geogra-
phies.
Cross-Border Links
Some global CSDs have already deployed
solutions that allow market participants to access
collateral across borders (e.g., Euroclear’s planned
“Collateral Highway”). For firms that would like to
develop this service, the three top priorities from
a technology perspective are:
• Manage a collateral giver’s pool across mul-
tiple depositories: The collateral management
system should be able to:
>> Detect unused collateral in a collateral
giver’s account with an agent/depository
based on the eligibility rules submitted by
the giver.
>> Generate instructions to move it to the
giver’s account with another depository (in
a different geography). This may involve
generating cross-border instructions from
a giver’s account with one agent to the om-
nibus account of the agent with another
depository. Additionally, in case of likely or
pending corporate events, such movements
should be avoided or rolled back.
• Frequent synchronization mechanism: There
should henceforth be a mirroring mechanism
to synchronize the security balances between
the accounts of a collateral giver with all the
agents/depositories. The balances should be
updated both at a CG account level and at the
omnibus account level of one agent/depository
with another. As real-time synchronization
between two cross-geographic depositories is
a challenge, the process should occur at the
start/end of day and at an agreed frequency
intraday.
• Establishing standard communication links
(e.g., SWIFT): This is absolutely necessary
between the market participants like deposi-
tories, settlement agents and cash corre-
spondents. The link should allow sharing of
mirroring and settlement instructions between
the giver’s account, parameters for transfer-
Source: Cognizant
Figure 4
Repo
Treasury
Derivatives
Operations
ProductLines
Equity Cash Commodities
OTC
Derivatives
Foreign
Exchange
Fixed
Income
Securities
Lending
Legal Docs
•GMRA
•ISDA
•CSA
•MNA
Collateral Management in Silos

7. cognizant 20-20 insights 7
ring collateral and communicating with agents/
depositories.
Dispute Resolution System
A dispute resolution system (DRS) is becoming
a strong selling point for collateral management
solutions. Counterparties can have a dispute over
a collateral call typically due to an underlying
trade being missed by either counterparty or dif-
ferences in the trade valuation philosophy. A DRS
should comprise the following features:
• Odds-based portfolio reconciliation: Regular
reconciliations outside the dispute cycle are
required to identify potential disputes early. In
the case of complex trades, reconciliation can
involve market experts and can be expensive.
Hence, it is important to take into account the
probability of default and focus on the most
suspect counterparties such as counterparties
with a suspicious credit history or counterpar-
ties not using the same data formats.
• An automated end-to-end dispute resolution
mechanism: In the event a dispute arises, a
meticulous reconciliation of both counterpar-
ties’ views of the contract, trade and valuations
is required. A real-time view of the margin calls
should be available. The Credit Support Annex
(CSA) in ISDA lays out rules for settlement of
disputes arising from valuation differences and
is the most commonly followed. These rules
should be implemented by a DRS.
However, it is not just the confirmation of the
reason for the dispute but the actual resolution
of the dispute by getting trades rebooked and
revalued that differentiates a fully automated
dispute resolution system from others. Work-
flow tools are required to manage the time-
consuming process of actually resolving those
differences.
• Real-time view: A real-time view of all active
margin calls and their status via an Internet
portal is also a necessary feature to prevent
disputes arising due to asymmetric information.
Reporting Infrastructure Upgrade
Collateral management firms are looking to build
a robust reporting infrastructure that is user
friendly and easily customizable. The reporting
engine should be able to fetch the data both on
a real-time and on a periodic basis as required
by the end user. Participants are now looking to
provide reports through new channels such as
Web interfaces and mobile devices in addition to
the existing proprietary receiving channels of their
clients. This requires integrating the reporting
data into a common enterprise-level information
layer. The multiple channels can then fetch data
from a common source to ensure consistent infor-
mation is reported through the various channels
and to various stakeholders such as clients,
regulatory bodies and depositories.
Conclusion
Collateral management provides a new revenue
opportunity for custodians, clearing houses
and broker-dealers holding a large amount of
collateral. They stand to benefit by optimizing
collateral usage. They can also offer collateral
management as a service to their clients to dif-
ferentiate their main product offering from that
of their competitors. Change will be consistent
in the current regulatory landscape and more so
as trade boundaries continue to blur. A strategic
approach to IT rather than a set of tactical
solutions is required in the emerging environ-
ment. An analytically advanced technology
platform with an integrated view across asset
classes and capable of handling cross-border
transactions will be the key enabler in such a
case. A well modularized system based on sound
architectural principles will enable handling the
changes more efficiently. This will ensure that
available collateral is optimized across market
and asset classes, so that an exposure can be
covered in the most cost-effective manner.
References
• McKinsey working paper on risk, Number 25: “Assessing and Addressing the Implications of New
Financial Regulations for the U.S. Banking Industry.”
• “Key Data Elements to Achieve Dodd-Frank Compliance,” Ernst & Young.
• “Collateral Management: Beyond the Crunch,” Rule Financial.
• “CME To Roll Out Cross-Margining,” by: Kentz, Mike, Compliance Reporter, 15295699, 10/7/2011.
Database: Business Source Corporate Plus.
Footnote
1
Manmohan Singh and James Aitken, “Monetary and Capital Markets Department — The (Sizable) Role of
Re-hypothecation in the Shadow Banking System,” IMF Working Paper, July 2010.

8. About Cognizant
Cognizant (NASDAQ: CTSH) is a leading provider of information technology, consulting, and business process out-
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Teaneck, New Jersey (U.S.), Cognizant combines a passion for client satisfaction, technology innovation, deep industry
and business process expertise, and a global, collaborative workforce that embodies the future of work. With over 50
delivery centers worldwide and approximately 162,700 employees as of March 31, 2013, Cognizant is a member of the
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About the Authors
Saugata Chaudhuri is a Consulting Manager in Cognizant’s Business Consulting Group. He has over
10 years of experience in investment management, securities services, private banking and asset and
wealth management. He has executed several strategic engagements in the collateral management
space for leading depositories to create and deliver service innovations to their clients. He can be
reached at Saugata.Chaudhuri@cognizant.com.
Ras Bihari Singh is a Senior Consultant within the Cognizant Business Consulting Group’s Banking
and Financial Services Practice. He has seven years of experience in the capital markets domain with
knowledge in collateral management, trade settlement and asset-based securitization. He can be
reached at RasBihari.Singh@cognizant.com.
Kausik Mondal is a Senior Consultant within the Cognizant Business Consulting Group’s Banking and
Financial Services Practice. He has eight years of experience in IT and has worked primarily in the
capital markets domain with knowledge in collateral management and trade settlement. His areas of
interest include business analysis, requirements management and gap analysis. He can be reached at
Kausik.Mondal@cognizant.com.
• “Basel III: International Framework for Liquidity Risk Measurement, Standards and Monitoring,” Basel
Committee on Banking Supervision, December 2010.
• “The New Basel III Framework: Navigating Changes in Bank Capital Management,” A publication
(October 2010) of PwC’s Financial Services Institute (FSI).
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von Pfoestl, Jacek Kochanowicz; Accenture.
• “More than Ever, Collateral Management Is Central to Regulatory Compliance and Commercial
Success,” Capco.
• BFS_SET_Regulation_Dodd_Frank_1, Cognizant Business Consulting.
• The Journal of Finance • Vol. LXVI, No. 2 • April 2011, “Bankruptcy and the Collateral Channel,” by
Efraim Benmelech and Nittai K. Bergman.
• “The (Sizable) Role of Re-hypothecation in the Shadow Banking System,” Manmohan Singh and
James Aitken, International Monetary Fund, July 2010.
• “Is Collateral Becoming Scarce? Evidence for the Euro Area,” Anouk Levels and Jeannette Capel, De
Nederlandsche Bank: Occasional Studies, Vol.10/No.1 – 2012.
• “Collateral Dispute Resolution – Reconcile Your Differences,” Cubematch.
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September 2010.
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