From inertia to acceleration: scaling tri-party VM and collateral reuse

A. C./Unsplash

Can targeted operating fixes, micro-networks and dedicated tokenisation funding catalyse network effects and expand non-cash variation margin (VM) at scale?

In March 2021, a single container ship blocking the Suez Canal disrupted nearly $10 billion a day in global trade. Ships were diverted around the Cape of Good Hope, delivery timetables were stretched and companies were reminded how dependence on a single primary route can amplify disruption.

Collateral managers see echoes of that episode in VM practices. Markets have built a highly efficient framework based around cash, but risk fragility as balance sheet pressures mount. Buy-side firms seek alternative routes – from government bonds and investment-grade corporates to, potentially, tokenised collateral.

But it’s not all plain sailing. Despite growing demand from the buy side, operational inertia, documentation hurdles, and uneven appetite and incentives across the market mean not all parties have been pulling in the same direction.

According to the International Swaps and Derivatives Association’s annual collateral survey, some 31.6% of all VM received at the end of 2024 was non-cash, the highest level recorded to date, and one that continues a growing trend.

In a follow-up survey conducted by Risk.net in September, tier one dealers revealed that roughly 7% of VM is now settled in non-cash collateral, while buy-side firms – including tier two and tier three banks that typically face tier one dealers as counterparties – average closer to 10%.

31.6%

of all VM received at the end of 2024 was non-cash

Asked to state their preferred level in the absence of any hindering factors, one-quarter of banks (26%) said they would prefer to continue posting cash only, while one-third of buy-side respondents said they would ideally deliver 15%–25% of their margin in non-cash form.

To explore what’s driving the shift – and the factors holding it back – Risk.net and BNY convened a roundtable during which participants shared practical insights on the subject. Senior collateral experts from dealers, buy-side firms, custodians and market infrastructure providers weighed in on the future trajectory of the VM ecosystem.

Buy-side momentum

Micro-networks of counterparties and vendors offer a potential starting point: insurers with deep corporate-bond inventories and smaller, more flexible banks can pilot reuse corridors that demonstrate velocity and return on investment.

According to one buy-side derivatives specialist, the strongest appetite for non-cash VM is coming from insurance firms and pension funds. Insurers, whose liabilities are discounted off the swaps curve, already hold substantial portfolios of long-dated corporate bonds. Extending VM to those assets has been a natural progression and, for many, it has become the default approach, the derivatives specialist explained.

Pension funds, on the other hand, remain centred on gilt portfolios and obtain most of their leverage through the repo market rather than long-dated, over-the-counter derivatives. Their move into non-cash VM has therefore been slower and more selective, influenced as much by post-liability-driven investment liquidity considerations as by portfolio structure.

“Almost all of the derivatives we now trade are on non-cash credit support annexes,” the participant added. The trend predates the gilt-market turmoil of 2022 but “post-2020 and the dash for cash” pushed insurers deeper into corporate-bond VM. “For insurance companies in the UK … it is the main way they collateralise.”

Receiving cash, by contrast, can be problematic. “Post Basel III, custodians don’t want my overnight cash, so I get some awful penal interest rate … there is a drag,” the derivatives specialist said.

Geographic location is another consideration. One participant noted that different European markets favour different asset types – for example, jurisdictions in which covered bonds or particular corporate segments dominate local investment. These variations affect which assets buy-side firms are naturally long and which they would prefer to post for VM. But capital and funding rules do not always support the acceptance of those assets, making cross-market harmonisation difficult.

Almost all of the derivatives we now trade are on non-cash credit support annexes … For insurance companies in the UK … it is the main way they collateralise

A buy-side derivatives specialist

Dealer constraints

Banks recognise the same underlying shift but face a different set of constraints, with Basel III at the forefront. Leverage-ratio effects, liquidity rules and the cost of balance sheet usage all influence whether non-cash is economical.

Dealers also alluded to the operational lift required when VM moves beyond cash. Managing a broader set of assets means reworking valuation and eligibility checks, aligning haircut schedules, and managing complexities around recalls and substitutions. With corporate bonds, for example, firms must handle multiple line items, maturities and settlement requirements, said one dealer.

The day-to-day mechanics can also be a problem. Coupon payments, corporate actions, income events and settlement-cycle differences each require monitoring and, in many cases, manual intervention.

Firms must also ensure that what comes in can be put to work elsewhere. Dealers emphasised that collateral needs to flow back into their broader inventory pools – repo, financing, prime brokerage – rather than sitting in an isolated bucket.

There was broad consensus around the table that VM infrastructure still reflects an era when cash was king. The operational realities of managing securities daily, particularly across markets with different settlement conventions, make adoption more difficult.

This sentiment echoes the findings from the Risk.net survey, in which operational complexity was cited as the number one barrier to using non-cash VM.

Joining the tri-party

Given those frictions, could tri-party infrastructure – whereby external agents handle operational processes, including collateral selection, valuation, settlement and optimisation – offer a viable solution? Several roundtable participants said that firms using tri-party for initial margin (IM) are beginning to ask why VM should be handled differently.

“The pipes are ready. For a lot of clients, it’s a natural next step,” said one agent.

Yet the market is far from aligned. Unlike IM, VM lacks a regulatory mandate to encourage tri-party adoption. Dealers commented that supporting tri-party VM requires more than a switch-on: it means changes to legal documents, control frameworks and integration points across risk, treasury and operations, most of which come with a cost.

As a result, the concept often “doesn’t get very far in the sell-side conversation”, the agent said, despite buy-side interest. Where IM benefited from a regulatory push through uncleared margin rules, VM relies on commercial demand. And that demand is still forming.

For this reason, scale remains a problem. Tri-party works best when large sections of the market operate through it, allowing incoming and outgoing assets to be rehypothecated across the same network. “You’ve got to build the scale; join the dots,” one participant said. Without that, collateral pools remain fragmented. Some participants described pockets of activity with regional or mid-tier banks, but nothing resembling a co-ordinated shift.

The tokenisation opportunity

In the absence of any other obvious or immediate stimulus, there was some support for the idea that tokenisation of assets could prove a catalyst for change, with the potential to shape collateral mobility over the longer term. One collateral specialist highlighted that faster settlement through tokenised assets would enable more flexible or intraday margining. Another noted that, in the current environment, digital asset initiatives often have budget attached to them and may be easier to gain board approval in a way that incremental VM upgrades may not.

There was also recognition of the long-term potential. If tokenised assets – whether money-market funds, government bonds or other high-quality instruments – could be mobilised through established tri-party frameworks, they could open asset pools that are currently hard to use. One agent suggested that tokenisation could help “unlock” assets such as gold or other precious metals, provided they can be settled through the same trusted infrastructure. But others cautioned that the challenges in tokenised collateral mirror those in VM more broadly – the need for network effects, standardisation across platforms and a clear framework for rehypothecation. “You would need the same interoperability between the different blockchains,” one participant said.

Reuse, too, was seen as a sticking point. A sell-side participant argued that, if institutions already struggle to harmonise rules for rehypothecation in today’s systems, the challenge will likely be greater on blockchain networks that lack common standards.

But the momentum behind tokenisation could be used to fund tri-party VM upgrades, such as documentation packs, event automation and interoperability tooling, according to one dealer. Tokenised assets could be anchored on tri-party rails to address platform interoperability and enable reuse within trusted custody frameworks.

Where next?

Network effects are engineered, not discovered. Participants agreed that the trend towards non-cash is here to stay, with several smaller factors contributing to this change rather than a single ‘big bang’ moment.

To this end, tri-party could provide the operational backbone, tokenisation could unlock budget and new asset pools, and micro-networks and reuse corridors could create repeatable wins that compound into scale.

As one participant concluded: “It’s a slow burn … but the trend will continue.”

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