Soros to implement collateral management trade solutions

Algo Collateral system to provide derivative margining

Soros Fund Management is implementing a collateral management solution, enabling a strategy of turning collateral agreements into profit-making trades.

The New York-based hedge fund giant has licensed the Algo Collateral system from Algorithmics, for over the counter (OTC) derivative margining.

The solution is more commonly associated with sell-side institutions, who make thousands of collateral agreements daily and have to reconcile them at the close of business. Algo Collateral will principally help Soros do exactly this, cutting the amount of manpower required.

However, the majority of fund managers have no such system, according to Thom Severance, managing director for North America at Algorithmics, which he said gives Soros an edge in finding potential arbitrage opportunities.

'Collateral refers to products that are given to one counterparty overnight or longer to cover a certain position with the other counterparty,' said Severance.

'At the end of the day the hedge fund will look at its total exposure to a counterparty. If it is over a certain amount they will have to post collateral ' for example, Treasuries ' to bring the exposure back down to the right level. Most hedge funds manage their collateral internally, but with the increase in derivatives trading, they need to reduce the operating costs and manage things more efficiently.

'With this system you can manage the collateral side of a fund effectively and turn it from a cost centre into a profit centre. I think hedge funds are interested because there is arbitrage between the margin agreements of different brokers. There are so many inefficiencies because most people are not managing their collateral with an efficient system ' they are still using Excel.'

He added that a number of larger hedge funds are showing a keen interest in the use of collateral management software. Aside from institutions, he said it was previously only derivatives specialists who were interested in collateral management, but single strategy hedge funds appear to be diversifying. 'It is ironic our first customer of this solution was in fact a hedge fund, but otherwise it was the larger companies. Hedge funds are becoming more sophisticated and the only alternatives are to build your own management system, or throw people at it.'

In addition to margin calls for OTC derivatives, Severance said margin is also calculated in foreign exchange and repo trades, thus an amount needs to be posted similar to the way collateral for OTCs is posted.

'Many firms are now looking at cross-product margin which would combine foreign exchange, repos and OTCs,' he added.

Michael Zerbs, chief operating officer at Algorithmics, said uncertain economic conditions are another reason Soros may have made its decision.

'Buy-side institutions need robust and scalable collateral management systems in place to mitigate credit risk. In particular, Algo Collateral's Asset Management module will give Soros greater flexibility and transparency when managing its collateral pools and optimising its assets.'

The software began implementation in March and according to Severance, a normal deployment takes around two months to complete.