Project Colin: why Goldman-led margin hub fell apart

The world’s big dealers quietly started work on a new swaps market utility last year, dubbed Project Colin. The aim was to control the vast collateral flows arising from incoming bilateral margining rules, but the consortium has since fallen apart, and a coalition of middleware and back-office firms have stepped into the breach

Dealer consortium had big plans for Colin

Nothing imbues glamour like a top-secret project with a mysterious codename, so when collateral managers at the big swap dealers started work on a new margining utility last year, it was a chance to cloak themselves, for a while, in a little intrigue.

They called it Project Colin.

It was a missed opportunity, because the sensitivity around the project is real, and the stakes are high. The aim of the hub was to control the huge new collateral flows that will result from incoming rules on margining for non-cleared derivatives trades - handling messages, disputes and the transfer of collateral. In total, regulators have estimated the regime will consume anything from €700 billion to €1.7 trillion in initial margin and, without a new utility, dealers feared additional costs and complexity would kill the market.

Participants all signed non-disclosure agreements (NDAs) and even though Project Colin was disbanded early this year – to be supplanted by a coalition of technology and processing firms – none of those involved are willing to put their name to it.

At the International Swaps and Derivatives Association, which is building a standardised initial margin model (Simm) for use in the regime – another pillar in the industry's attempts to preserve the non-cleared market – those involved in the work even sought to avoid learning about Project Colin.

That consortium no longer exists. These were the big 12 or 14 international banks, but they found it difficult to get the funding to build the utility

"I try to not be aware of the various initiatives out there, because I would have to sign an NDA if I was aware of what they are working on. Our focus is on the Simm and protocols around updating collateral support annexes, which we expect to make available to different middleware providers to conduct all the necessary connectivity work," says a member of the Simm working group.

The beginning

Project Colin was the product of rules drawn up by the Working Group on Margining Requirements (WGMR), a joint project of the Basel Committee on Banking Supervision and the International Organization of Securities Commissions (Iosco). Simply put, regulators wanted to extend the safety of central clearing to non-cleared trades – as well as removing a possible incentive for the market to avoid clearing (Risk April 2015).

In September 2013, the WGMR proposed that all covered swap counterparties should exchange variation margin on non-cleared derivatives trades from December 1, 2015, with initial margin also to be exchanged if both counterparties had more than €3 trillion in notional outstanding of non-cleared trades – the notional threshold would drop each subsequent year, reaching €8 billion on December 1, 2019. Regulators in the EU, Japan and US subsequently issued proposals that would translate the international rules into domestic regulation, albeit with discrepancies that will make life difficult for cross-border transactions (Risk November 2014).

One of the big challenges is operational, with one bank said to be anticipating a sevenfold increase in the volume of margin it handles.

"We think the impact will be much more significant in variation margin posting, and I expect the operational burden placed on institutions will be huge. We spoke with one bank that thinks its margin call volume is going to go up by around 700%. When you consider that, you realise what needs to be done. The process today is quite siloed and quite manual, and there is a need to automate across those silos and make the process as simple and as efficient as possible," says David White, head of product marketing at TriOptima in London.

The industry pleaded for more time and, earlier this year, the Basel Committee and Iosco pushed back the start date for the regime, with initial and variation margining now due to come in from September 1, 2016 for the market's biggest participants, and the big-bang deadline for variation margin posting by all other covered entities set at March 1, 2017. At the time of writing, however, EU and US regulators had not updated their own rules to reflect the postponement, leaving the industry still technically facing an end-2015 start.

This was the deadline Project Colin's architects were working to when they first met in 2014. The need for more automation in collateral management was one of the big drivers.

"Today, we receive margin calls in an email. Each of the dealers has its own collateral management systems where trades are booked, the system generates a report – often a spreadsheet – and then the client receives an email, sent out by that system, saying how much needs to be paid and by which side. We check the reports – and you ought to check them – because there are frequently errors where the trade has been booked incorrectly. For example, we might see dealers have booked a trade they have done with another fund manager to our fund, so you have to read the report to get those errors corrected," says one London-based hedge fund manager.

But the margin calculation and calling system has at least some degree of automation. When it comes to transferring segregated margin to a third-party custodian, messages continue to be faxed in many cases.

"Processing the movement of the collateral into third-party segregation today is hugely laborious. It involves manually accessing an individual custodian's system, and in most cases this is still done via fax. Why? Well, that's just the way it is done," says Craig Welch, co-founder of Boston-based margin messaging service provider AcadiaSoft.

These practices may be able to cope with current collateral posting practices, but the new rules will expand the number of firms posting, the amount of collateral flowing through the system, and also introduce new wrinkles, such as the need to track and consolidate counterparty exposure – under the WGMR rules, initial margin is only required once exposure has passed a €50 million threshold on a group basis, meaning a dealer might be trading with multiple funds belonging to the same asset manager, and would need to track the consolidated exposure to know when margining takes effect.

Project Colin was led by collateral managers at Goldman Sachs, according to people with knowledge of the consortium's work. Goldman executives co-ordinated the early discussions between the other banks – understood to be the 14 largest derivatives dealers, known as the G14 – and convinced them of the need to act.

The consortium planned to build a shared infrastructure, jointly owned and developed by the participating banks, which would allow their disparate in-house collateral management systems to plug into a central hub.

It would serve at least three distinct functions: first, it would allow automated margin messages to be passed between the participating dealers, which would require a common messaging standard; then, once a standard existed, the hub would also need to spot and fix any margining discrepancies; finally, once disputes were settled, the utility would need to electronically transfer the collateral - whether in cash or eligible securities – to an independent custodian.

The hub might also need to conduct the margin calculations for its users – a fourth pillar – but this element is said to still be up for debate.

The beginning of the end

If the dealers behind Project Colin could overcome the associated challenges, then opening the gates to the buy side would be comparatively straightforward, the thinking went. But then, in late 2014 or early 2015 – getting a more exact date is difficult – the principals behind the effort abruptly threw in the towel.

"Project Colin was a formal consortium pulled together last year to build a collateral utility. They issued a number of requests for information into the technology vendor market looking for candidates to build the systems they wanted. The sponsors were the big swap dealers, but it was led by Goldman," says a source at one software vendor.

"That consortium no longer exists. These were the big 12 or 14 international banks, but they found it difficult to get the funding to build the utility. I think for any bank to write a cheque for several million dollars is not something the head of a desk or the head of a business unit can do today the way he could 10 years ago. It's tough for banks to spend money in that slightly speculative way now," he adds.

In addition, it became clear to the dealers that they might be better off working with what they already had – in the case of eight members of the G14, that includes ownership stakes in AcadiaSoft.

"Project Colin has been shut down and parts of that effort have been folded in under AcadiaSoft – but only parts. That is because all but two or three of the participants in Project Colin – the G14 banks – are shareholders in AcadiaSoft. It made more sense than having two separate efforts that would work with each other on margin issues," says AcadiaSoft's Welch.

The Boston-based firm launched its collateral messaging platform in 2011 as a joint venture with eight swap dealers: Barclays, Credit Suisse, Deutsche Bank, Goldman Sachs, HSBC, JP Morgan, Morgan Stanley and State Street. By 2014 it had established itself as the primary messaging provider for margin calls across the industry – routing XML messages between participants on its system, as opposed to the more basic email standard that still prevails outside the AcadiaSoft network.

The firm allows the in-house collateral management systems of its stakeholder banks to be transmitted across its network alongside the margin systems offered by independent software vendors that sell their technology to asset managers, institutional investors and other swaps market participants. Collateral service providers such as CloudMargin, Lombard Risk, SmartStream and SunGard route their messages across the AcadiaSoft messaging network and can communicate with the internal systems of the swap dealers active on the service.

In mid-2014, when Goldman began to discuss the idea of Project Colin with its dealer counterparts, this messaging service was all AcadiaSoft had to offer, but – unknown to Goldman – the firm was already in discussions with TriOptima about adding the next piece of the utility puzzle to its offering.

TriOptima's portfolio matching service triResolve reconciles 75% of all bilateral over-the-counter derivatives trades globally and 90% of all collateralised derivatives transactions across a total of 1,400 users. This kind of ability is vital if the margin utility is to work smoothly. While Isda's Simm aims to give market participants a shared, simplified margin calculator, two counterparties could still generate different margin numbers, albeit within limited bounds. As a result, the utility will have to identify the source of the discrepancy and resolve the dispute.

"Using the Simm approach, two counterparties could apply the methodology in a slightly different way, and as a result their final number might come out slightly differently. If we have a five-year rates swap, the risk sensitivity input on that trade will be DV01, and the standardised risk weight applied will be 40 basis points, a weight based on the maximum possible move in interest rates over a 10-day horizon based on historical data," says Tomo Kodama, a managing director in counterparty portfolio management at Bank of America Merrill Lynch in New York.

"My model may compute the sensitivity to be $4,500 per basis point, while your model may compute the DV01 to be $4,600. Multiplying the sensitivity by the 40bp risk weight, I would compute the initial margin to be $180,000, while your model computes it to be $184,000. Even though our models are the same and we are doing the same calculations, your sensitivity might be slightly different to mine, but the final initial margin number should be within some tolerance level," Kodama adds.

Entrenched position

That is why AcadiaSoft and TriOptima started talking – and why Project Colin was sidelined. A partnership between the two firms would give them an entrenched position in two of the key services to be provided by the dealers' mooted utility.

"It was in September or October 2014 when AcadiaSoft and TriOptima made it known to the G14 that we had a handshake agreement to create a link between the two. At that point, it became clear that when you factored in AcadiaSoft's existing links to all of the collateral vendors, and the fact that TriOptima was already doing almost all the portfolio reconciliations in the market, that there was no logical reason for Colin to continue on its own," says Welch.

Eight months later, the AcadiaSoft-TriOptima joint venture is yet to be formally announced, but news of their informal alliance did not drive the consortium to disband immediately. The would-be utility was still missing other pieces of the margin automation puzzle: potentially, a centrally hosted margin calculation service – understood to still be up for debate – and the ability to automate collateral transfers between counterparties and custodian banks, without having to fire up the fax machine.

Margin transfer brings in two established post-trade players – the Depository Trust & Clearing Corporation (DTCC) and Belgium-based settlement provider EuroClear. The two firms announced in September 2014 a joint venture termed the Margin Transit Utility (MTU) to facilitate the remittance of collateral between counterparties and custodians once the earlier parts of the messaging and reconciliation chain have been dealt with.

DTCC declined to speak with Risk for this article, but according to AcadiaSoft's Welch, terms have already been agreed to ensure margin calls and reconciliations undertaken by the hub will be delivered by MTU as part of an exclusive arrangement. Between these entities, three of the utility's pillars will – in theory – be in place and available from a single point. The challenge now is to have it up and running by early 2016, so there is time for market participants to get on board before the September 2016 deadline.

"AcadiaSoft will send a message to the MTU and DTCC-EuroClear will provide the electronic automation so the end-user's account at Euroclear's central securities depository will instruct the MTU to electronically move the collateral to the relevant custodian and then the confirmation report will come back through the system. That will be in place by September 2016, but realistically well before then. It will be an end-to-end process where today there are a lot of emails and faxes," says Welch.

The date of Project Colin's death remains unclear. Risk spoke with four of the G14 banks for this story, of which only one admitted the existence of the now-defunct consortium. Goldman Sachs was given the chance to review the elements of the story relating to the project, and declined to comment.

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