Asset backed crypto-currencies and derivatives in the blockchain.

Dear,

Two weeks ago we looked at the opportunity that Bitcoin (the most popular crypto-currency) represents for efficient management of payments .

https://www.linkedin.com/pulse/bitcoin-sap-banking-ferran-frances?trk=hp-feed-article-title

But, we know that Bitcoin is a very volatile currency which makes it unsuitable for offering other Financial Services like Loans or Deposits.

If you take a loan in Bitcoins, the Forex volatility of the Bitcoin can increase your debt or reduce your deposit value very quickly; for that reason, even merchants using Bitcoin, try to convert their Bitcoins to local currencies like USD or EUR, just after receiving their payments.

Investing and lending is a substantial component of the Financial System, and we’ll not be able of building a robust Financial System supported by crypto-currencies, till we don’t fix the volatility issue.

Additionally, volatility in the value of assets and liabilities, included crypto-currencies, increases the Value at Risk of the exposures, with its correspondent capital consumption, and this is a big issue in times of capital scarcity.

In order of tackling the crypto-currencies volatility issue, the next evolution in the world of the crypto-currencies are the "asset backed crypto-currencies".

And remember, what’s important about the crypto-currencies is not the currency itself, but the technology which makes them possible; “The Blockchain”.

Asset backed crypto-currencies are derivative contracts (forward contracts) posted and managed in the blockchain. The underline of those derivative contracts is a commonly traded asset, like Gold, US dollars, Euros or Chinese Yuan Renminbis, which gives transparency to the value of the asset backed crypto-currency and reduces its volatility.

In fact, as in any other forward contract, the value of the asset backed crypto-currency matches the value of its underline (spot price) at maturity date, building the mechanism for reducing the crypto-currency volatility value.

The underline of the derivative can be physical, but this is not necessary, as the asset backed crypto-currencies can also be built as synthetic derivatives with cash settlement, mitigating the counterparty risk by introducing higher collateral requirements.

Derivatives trade is one of the biggest opportunities for Blockchain based startups; the volume of the Over-The-Counter derivatives market is around $700 trillion negotiating in a very expensive and inefficient market, which has become even more expensive with the introduction of the new regulatory framework (Dodd-Frank in the US and
EMIR in Europe) and their increasing capital requirements.

The dominance of big banks in derivatives trade has been already threatened by new startups like trueEX, which three years after receiving authorization from the U.S. Commodity Futures Trading Commission, manages around 20% of the Interest Rate Swaps market in the U.S

https://www.trueex.com/about-us

But these startups are still subject to the ruling of the clearinghouses network.

What will be the impact of replacing them with a much more transparent and efficient network, like the blockchain?

Think about it, the financial system, as we know it, is being threatened by three major forces.

- Over-leverage and capital scarcity.

- More stringent regulation.

- A technology revolution introducing more efficient and dynamic players.

Do you think that obsolete banking technology and processes are going to survive to this revolution?

Traditional banks have to reshape, implementing best practices, and integrated systems capable of providing capital efficiency and supporting the technology revolution.

We’re working already on the integration of new technologies like blockchain in standard SAP processes; I’ll describe some of them in future posts.

Looking forward to read your opinions.

K. Regards,

Ferran.

Join the SAP Banking Group at: http://www.linkedin.com/e/gis/92860

Collateral Optimization with SAP Bank Analyzer.

Dear,

New regulation requesting central clearing of derivatives contracts and higher capital requirements, limited economic growth, and an overleveraged financial system are putting much pressure in collaterals management departments of financial institutions, for providing an efficient management of their instruments.

Unfortunately, collateral optimization is a discipline limitedly known for most of bank’s collateral managers.

Collateral optimization function has two main dimensions.

• Transactional management of the collateral rights.

• Utilization and distribution of the collateral rights.

In a future post we’ll look at the first dimension, but today we’ll focus in the efficient utilization and distribution of collateral rights.

The collateralization problem requires the allocation of a heterogeneous set of collateral pools to a number of assets with different values, maturities and risks estimations.

Solving the collateral optimization problem requires finding the optimal distribution of the collateral portions to the assets, which minimizes the bank’s capital requirements.

I’m sure you’re aware that in a real life example; solving the problem requires, evaluating a huge number of different combinations, of assets and collateral portions.

Traditionally, the process of allocating collateral portions against assets has been performed as a manual function. In this approach, collateral managers, choose the most suitable collateral portion, as collateral requirements are identified. They perform the function by trying to reduce maturity mismatches, estimating potential haircuts, etc. 

Once the link has been established, it will not be dissolved till the collateral requirement disappears or the collateralization agreement expires.

While this could be considered an optimal allocation of the collateral rights in times of capital abundance, it’s far from being optimal in scenarios of capital scarcity.

The optimal solution requires considering, not just the new collateral rights and available portions, but the full inventory of the bank’s assets and collateral pools, and estimate if a more optimal distribution can be achieved, by redeploying the collaterals pool to the full inventory of assets.

Don’t forget that the reality is dynamic; and for instance, changes in the yield, rating of the counterparty, or the collateral value will impact the optimal solution of the collateral distribution problem.

As a consequence of these dynamically changing equation, collateral optimization requires continues rebalancing of the bank’s collateral allocation.

In order of running this process, the IT infrastructure of the bank requires a central repository of assets and collateral rights, which is at the core of the value proposition of the Integrated Financial and Risk Architecture of Bank Analyzer.

Currently SAP Bank Analyzer offers the Optimal Collateral Distribution functionality of the Basel III - Credit Risk module, which is insufficient for being considered a proper Collateral Optimization System for dynamically managed portfolios. But, we’re working in the integration of the necessary objects and results with external third-party systems, capable of running the optimization process.

In a previous post, we look at a practical example of the Bank Analyzer-Special Ledgers’ capabilities.

https://www.linkedin.com/pulse/special-ledgers-sap-bank-analyzer-ferran-frances?trk=hp-feed-article-title

This is another good example; taking profit of the robust modeling of collateral data in the Source Data Layer, and the flexibility of storing the optimization and simulation results in the Special Ledgers of the Results Data Layer, we can build the central repository that the collateral optimization process requires.

Looking forward to read your opinions.

K. Regards,

Ferran.

Bitcoin and SAP Banking.

Dear,
If I ask you if you’ve heard about Bitcoin, I’m sure you all know it’s a cryptographic virtual currency.

But if I ask you about Blockchain, I think it will be the first time that many of you have seen this word.

Blockchain is the protocol supporting Bitcoin payment transactions, and the technology which is going to drive the biggest transformation in payment methods, since Bank of America launched the first credit card on 1958 (BankAmericard).

The first reason is cost; Bitcoin fees are very low (zero in most cases), while Creditcard fees are around 3.5% of the transaction value.

On the other hand, you probably know that Bitcoin is a very volatile currency (due to its low monetary mass compared to the major currencies), but this weakness has opened the opportunity of new services for hedging the Forex risk in Bitcoin transactions, the most popular one is bitpay
https://bitpay.com/

Combine a new technology, capable of a dramatic reduction of payment costs, with a world of limited economic growth, putting pressure on reducing costs; and you will understand the opportunity that Bitcoin represents.

And remember that the real importance of Bitcoin is not in the currency, but in the Blockchain technology.

In few words, Blockchain is a shared public and encrypted, decentralized ledger.

Every payment in the Bitcoin network is posted as a transaction in the Blockchain ledger, opening the gate for posting, not only the transfer of money, but any agreement, representing a right or obligation, with its correspondent value.

Financial Contracts (Loans, Deposits, Options, Forward Contracts, Swaps) are just that, transfers of rights and obligations, and their correspondent value, between two counterparties.

With the Blockchain protocol, we have the capacity of developing new services for value transfer, encapsulated in “smart” financial contracts.

Blockchain represents to the Internet of Value, what the TCP/IP protocol has represented to the Internet of Data.

When Vint Cerf and Bob Kahn developed the TCP/IP protocol in the 70’s nobody could imagine that Facebook or Linkedin were going to change the way that humans interact. In the same way, it’s very difficult to imagine how new services developed on Blockchain are going to change the way in which value is transferred.

In the next 10 years we’re going to see many startups developing new services on top of the Blockchain protocol, services that will modify the shape of the financial system forever.

At the same time, the mobility paradigm is changing the interaction model between the financial system agents.

SAP is aware of the importance of this paradigm change, that’s why it’s delivered SAP Fiori, opening the gate for the integration of internet services in the SAP Banking landscape, including Blockchain services.

https://www.sapappsdevelopmentpartnercenter.com/en/build/sap-netweaver-gateway/sap-fiori/

But the transformation can’t be limited to the interface; the opportunities of the technology change are also threats for those who are not capable of reshaping their business processes according to the new paradigm.

And the question is; how to reshape your business processes if they rely in obsolete legacy systems developed when Internet was not even a dream.

I’ve worked as SAP consultant for more than 20 years, and in SAP Banking for the last 10. When I look at the bank’s systems; I see business processes isolated in silos of information supported by multiple, heterogeneous customer and products databases.

By making these processes visible on the Internet they are just showing their weaknesses to new and more agile competitors. Paypal is a good example.

We’re working already in new business processes leveraging SAP Technology towards the new paradigm; you will see some examples in the next posts.

Today is the time to start the change, tomorrow can be late.

Looking forward to read your opinions.
K. Regards,
Ferran.

“Special Ledgers” in SAP Bank Analyzer.

Dear, 
A common issue in Bank Analyzer implementations is determining the scope of the data that we must include in the Accounting or Credit Risk Calculations. 

The Primary Objects of the Source Data Layer contain the Real World Data (Transactional Data, Master Data and Market Data), like Disbursements, Business Partners Data or Interest Rate Curves.

Primary Objects are processed in the Processes and Methods Layer and the result of these calculations is stored in the Results Data Layer. 

In addition to regulatory results data, customers require other non-regulatory data for internal analysis, which is related to the Credit Risk or Accounting results, but it’s available in different granularity, or it’s generated by internal models which don’t belong to the Accounting Principles. 

We could be tempted to modify the standard RDL structures for storing that data, and this is not the best approach. 

Some of you, with long experience in Accounting, are familiar with the concept of Special Ledgers; in those Ledgers we store accounting related data that don’t belong to the Principal Ledger. 

In the Bank Analyzer RDL, we also have the possibility of creating “Special Ledgers” by using alternative Result Areas and Result Types. They have a different name but they basically follow the same principle. 

Let me show you this with a practical example. 

Bank Analyzer has the Profit Analyzer module for managing Process Costs (and other internal costs). 

Process costs are the cost related to maintain a Financial Contract; but those costs are distributed amongst many areas of the bank; like software and hardware amortization costs, call-center costs, etc. 

In SAP we have the Controlling functionality, including Cost Center Accounting, Internal Orders, Activity Based Costing, etc for managing internal costs. 

But Internal Costs are available in granularities very different to the Financial Instruments Ledgers. For that reason, Profit Analyzer manages those internal costs as standard costs, with a Rate that should estimate the portion of the actual costs which belong to a specific financial contract. 

Consequently we need to build controlling models and reporting capabilities for reconciling standard and actual process costs. 

A good alternative is transferring the actual costs results to Special Ledgers (alternative Result Areas and Result Types) in Bank Analyzer, making them available for determining accurate Process Costs Rates that will be used in Profit Analyzer. 

Building “Special Ledgers” in Bank Analyzer has many advantages: 

- They’re built on top of the Financial Database assuring consistency with regulatory data and facilitating reconciliation. 

- Results are fully visible by using CVPM processes that will make their data available for other Bank Analyzer processes and reporting processes. 

- They increase the flexibility of the system without changing the standard delivery or contaminating standard Result Areas or Result Types with intermediate or internal reporting data which don’t belong to the regulatory Ledgers. 

I’ve heard too many times that Bank Analyzer is not flexible enough, or even worse, I’ve seen modifications of the standard system breaking the consistency of the sub-ledger or damaging the business content, for fulfilling requirements that could be easily fulfilled in a more robust way by using the right approach. 

There’re many ways of fulfilling a requirement, but there’s only one best way of doing it. 

Looking forward to read your opinions. 
K. Regards, 
Ferran.