Under the turbulent economic environment since 2008, derivative market participants have put collateral management under a microscope to determine how they can better protect against counterparty risk through enhanced collateral management systems. Dodd Frank legislation is also adding a sense of urgency and need for clear crisp processes.

Corporate treasuries and other investors continue to search for solutions to increase transparency and reduce counterparty risk. The Investments Operations team at Microsoft manages the operational complexities of confirming and settling a $62 billion portfolio including 40 ISDA CSA’s, 1,000+ OTC derivative positions and counterparty exposures averaging $250m and reaching as high as $1 billion. The size and complexity rivals those of large investment firms. Against this backdrop of a high risk environment, Microsoft’s Investment Operations team has been hard at work trying to fine-tune and automate its processes.

As Rebecca Chen explains, “We addressed the situation by outsourcing this function to our custodian bank, Northern Trust. What made this outsourcing successful was that we invested the time to improve our processes and define, in detail, the level of automation and success metrics that were important to us. We elected to use their existing systems rather than building one from scratch – leveraging the best.” The benefits of this project can be summarised as follows:

• Successful mitigation of counterparty risk by increasing the timeliness and transparency of daily valuation and position reconciliations. They now achieve a position matching rate of 99.9% with counterparties and have not experienced an issue with unresolved counterparty disputes outside of their tolerance, minimising the potential of uncollateralised risk.
• Minimised the operational risk and reduced human error: because of the systematic and automated processes performed by Northern Trust, they have mitigated the operational risk of human error occurring by no longer manually managing the terms of each CSA.
• Internal resource saving. They achieved substantial resource savings and created positive ROI by outsourcing collateral management. Their involvement is now minimal and instead of spending 40+ hours a week supporting the manual process performed by both the compliance and operations teams, the guidance provided by Microsoft is only exception based. Daily reports from Northern Trust allow Microsoft to review overall exposure in a much shorter time. Furthermore, it also eliminates the expenditures needed to develop and maintain an in-house solution.
• Potential benefit on financial reform: Microsoft can potentially leverage Northern Trust’s development to meet Dodd Frank Act regulation as it impacts its collateral management clients. According to the industry trend, it may be possible to net the collateral of cross-products with a central counterparty (CCP). With Northern Trust’s development, it can potentially save resources at Microsoft.

As Jayna Bundy concludes, “Given the turbulent markets, heightened credit risk and need for greater transparency, Microsoft’s team was focused on finding solutions to mitigate risk, increase operational efficiency, reduce labour-intensive processes and increase visibility and accuracy of counterparty exposure reporting. By outsourcing to Northern Trust, benefits were realised in managing risks and achieving straight-through-processing. The results paid off immediately in obtaining 100% position reconciliations and realising accurate, daily exposure reporting. This has dramatically improved OTC risk management.”