ISDA: Operational Frictions Impede Expanded Use of Non-Cash Assets as Variation Margin

ISDA found that operational frictions, rather than the movement of collateral itself, were the primary obstacle to expanding the use of non-cash assets as variation margin for non-cleared derivatives.

In a report based on interviews with buy- and sell-side firms, ISDA said the use of securities collateral for variation margin requirements was already widespread and expected to grow. Firms were motivated to use non-cash collateral to keep cash invested, avoid reliance on the repo market, and maintain a diverse pool of pledgeable assets. Active managers viewed pledged cash as uninvested capital, while pension schemes valued the ability to pledge a broad range of securities during liquidity stress events.

Despite the demand, ISDA said operational issues hindered the broader acceptance of eligible collateral. The report identified frictions in several surrounding processes, including inconsistent definitions of eligible collateral across credit support annexes, manual and burdensome substitution workflows, and difficulties in operationalizing concentration limits within core systems. Asset servicing for non-cash collateral, such as coupon payments and corporate actions, also required manual intervention that added cost.

To address these challenges, ISDA outlined a target future state guided by four principles: standardize, automate, optimize, and scale and elevate. Those cover standardizing collateral definitions and taxonomy, automating substitutions and asset servicing, optimizing collateral selection across all obligations, and elevating collateral management from a back-office function to a front-office discipline. ISDA said triparty arrangements and tokenization, along with money market funds and U.S. Treasury exchange-traded funds, each hold promise but are not yet a substitute for near-term improvement. According to the association, industry momentum is moving from pilot to production, and firms are pursuing interim operational fixes while those options mature.