June 30, 2025 (NO COMMENTS)

Growing use of non-cash collateral is whipping up interest in the use of tri-party structures – which are typically associated with initial margin posting – for meeting variation margin payments.

“We’ve having more and more conversations with clients on the buy-side about tri-party and we’re having conversations across initial margin and variation margin,” says Eileen Herlihy, global head of sales for trading services at JP Morgan.

At least one buy-side firm, an Australian superannuation fund, is already using JP Morgan’s tri-party platform for both initial and variation margin.

In a tri-party arrangement, many of the operational processes associated with exchanging securities collateral, such as selection, valuation, settlement and optimisation are handled by the custodian.

Other custodians also see growing buy-side interest in tri-party services for both initial margin (IM) and variation margin (VM).

“There has been a clear move towards tri-party for initial margin,” says Mark Higgins, collateral product head at BNY. “Third-party or bilateral works for a small buy-side firm posting cash or money funds, but where you’ve got multiple counterparties and multiple asset types, tri-party can make more sense. The client demand is there and we’re going down that path for variation margin as it’s a smooth way to mobilise assets.”

The custodian is upgrading its tri-party structure to receive VM in Title Transfer format, which is a legal mechanism for shifting ownership of the asset. This format is crucial for enabling reuse of the collateral within the system.

“The value to the dealer is the ability to reuse those assets, which could be as variation or initial margin, or could mean pulling it through the financing business and using it as a central Treasury function,” says Higgins. “Tri-party isn’t a one-trick pony. It’s increasingly being used holistically across initial margin, repo and securities lending.”

Brussels-based Euroclear is engaged in similar discussions. “We are definitely seeing increased participation by buy-side firms,” says Jan Grauls, head of Euroclear’s collateral team. “Historically, the buy side has been using tri-party to do repo, but now we’re seeing an interplay between IM, VM and repo and we’re speaking to buy-side firms on how they can optimise their use of collateral.”

These firms include pension funds, insurers, corporate treasurers and small banks. “We’re not the natural home for the buy side, but we have models for them to access Euroclear and have increased our membership,” Grauls adds.

Amy Caruso, head of collateral initiatives at the International Swaps and Derivatives Association says use of tri-party for VM is “fairly new” with discussions beginning around a year ago.

Give it a tri

Tri-party has been the custody model of choice for banks and the largest buy-side firms caught in the first four waves of non-cleared margin rules, governing the exchange of initial margin.

Hundreds of buy-side firms swept into the rules in phases five and six opted for the cheaper ‘third-party’ model, in which custodians provide settlement, while other processes such as collateral selection and valuation are handled manually.

Variation margin, which has been compulsory for non-cleared derivatives since 2016, has largely been managed bilaterally given the dominance of cash.

This is beginning to change. Isda’s latest margin survey shows more than 31% of VM was posted as non-cash at the end of 2024, up from a long-term average of around 20%. Of that non-cash amount, a little over half was government bonds, while the rest was securities including corporate bonds and equities.

“Some buy-side firms have been exposed to tri-party capabilities through initial margin and see definite upsides in terms of the operational simplicity that tri-party offers,” says a collateral head at a European bank. “As more and more post bonds as variation margin, the natural venue may not be bilaterally but through the tri-party agent.”

A recent transfer of sell-side talent to the buy side may also have accelerated demand for more optimised collateral setups, according to O’Delle Burke, JP Morgan’s global head of margin. “Buy-side clients started to hire a lot of investment banking folks with a high level of experience. They’re more familiar with how the market works so if they have used a certain asset class, like equities, which the buy-side firm is flush with, that’s a big opportunity to add more efficiency and improve their financing structure.”

Increased non-cash use introduces new challenges, which tri-party may help alleviate. In addition to valuation, selection and guaranteed settlement, these services apply relevant haircuts to specific instruments, handle coupons, dividends and corporate events.

“If you were to use a tri-party structure, equities would be much easier to move around,” says Isda’s Caruso.

Collateral substitutions and diversification are also critical requirements when posting corporate bond and equity collateral.

“From a buy-side perspective, it’s not the case that the pool of assets used as collateral is dormant,” says Burke. “They tend to be traded on in the market so the operational process to recall and substitute needs to be efficient. If a portfolio manager gets stuck not being able to recall that asset and get it to where it needs to be – if there are constraints or friction around that, it will curtail the level of activity you will see.”

Limits

There may be challenges to wider adoption. For example, VM received in a tri-party system can only be reused in that closed environment.

“The question is does the bank want to keep that outside tri-party or within tri-party? There could be a reluctance for banks to move the VM into tri-party because they may not get as much use out of it as if they were to receive those bonds by their normal settlement,” says Philip Forkan, collateral head at consultancy Tonic.

Tri-party may also prove too costly for many buy-side firms – one of the main reasons most stuck with the cheaper third-party approach for their IM implementation.

BNY’s Higgins says the operational benefits can outweigh the initial outlay. For example, he says one buy-side firm which took the tri-party plunge for IM reaped significant savings thanks to a reduction in settlement fails, which are penalised under Europe’s Central Securities Depositories Regulation.

He’s not the only one who sees potential savings. A large European pension firm is currently mulling a tri-party setup for IM. “We’ve been thinking about it and watching. On paper it’s a very advantageous proposition,” says a trading head at the company.

“Having your pool of assets and a cleared repo system attached to it should be very efficient setup. Right now we have to manage multiple pots of money from multiple destinations so I think that efficiency would lead to lower costs in the end.”

Yet the pension firm has no plans to extend this to variation margin and intends to stick with cash for this purpose, preferring to reserve securities collateral to post against cleared derivatives.

“Due to the cleared mandate, pension funds have to post more initial margin, which is as much as possible in non-cash collateral, so our utilisation of non-cash collateral has gone up. Our need to post IM in the non-cleared margin regime has also gone up, but for VM, it’s pure cash,” says the trading head.

While custodians are poised for further growth in non-cash VM use, the collateral manager at the European bank strikes a note of caution.

“VM on tri-party has been spoken about over the years on the derivative uncleared side, but think it’s going to be a slow journey rather than a significant shift right now. I don’t think we’ll see as steep an adoption curve moving forward, because people that were going to change the market have already made that move in the last few years.”