You have recently released a research report detailing a need for additional collateral to support the demands of the industry – what is the driver behind this need?
Benjamin Daniel: Working on related projects within Financial Risk Management and Collateral Operations, we have identified a consistent theme regarding client pain-points and the possible drivers for change. We believe it is important to be transparent about the components that are triggering additional collateral demand; and we have further projected this forward to the impending changes and new players in the collateral ecosystem through the implementation of the fifth and six waves of the Uncleared Margin Rules, in addition to the Basel III and IV requirements for liquidity management and reporting, such as the liquidity coverage ratio and the net stable coverage ratio.
Do you feel the securities industry has focused too much on efficiencies and optimisation which in turn has led to this perceived shortage?
Govind Daga: Not necessarily. Through efficiencies and optimisation, firms can better understand what inventories they hold, and therefore manage them more effectively, which should help address that squeeze on collateral availability. The shortage comes from the regulation and the increased bifurcation of the various demands to hold high-quality liquid assets.
Has the change in supply and eligible collateral had an effect on borrowing costs? If so, how?
Daniel: Indeed, a tighter eligibility schedule across the board and a reduced overall risk appetite among industry participants mean that both the supply of collateral and the amount of eligible collateral in circulation have reduced. This will naturally push up borrowing costs, as the collateral that people are trying to source is simply scarcer than before.
Has the collateral space become more sophisticated and is this being driven by regulation or technology or both?
Daga: Through the need to comply with the increasing demands of regulation, firms are inevitably forced to look towards technology for a solution. The two have gone hand in hand, and with the increasing opportunities for efficiencies and optimisation – such as blockchain and so forth – that will only increase.
Equally, firms are looking to get the greatest returns on their inventories and trading books. Therefore, wherever there is a competitive advantage for them, they will look for that optimisation. The creation of X-value adjusted desks puts the onus back on the business units requiring the use of collateral, as they can clearly see the actual cost, and so will be billed accordingly, giving everyone a greater incentive to make efficiencies and become more sophisticated. Nothing comes for free anymore!
In order to remain compliant, competitive and efficient, what areas will firms need to look at prioritising?
Daniel: The main area to focus on is data. Whether it is for the use of collateral, the quality of the collateral inventory (HQLA and liquidity risk management (LRM), or having a consistent taxonomy of traded positions and collateral that can be used to report of different aspects of collateral and liquidity management, that is focus on data is associated with various regulations and the calculations required to ensure compliance.
Are there any other trends in the collateral space which we should be aware of?
Govind Daga: Everything is being driven by centralisation, not just of inventory or sources, but also the usage across desks. Another key trend is linking collateral management to liquidity and capital management. Due to capital constraints and the need to maintain sufficient liquidity buffers, firms are being pushed towards enterprise-wide collateral management across desks, business lines and geographies.
Whilst it is not an unfamiliar trend, it is important to explicitly call out the move to a centrally cleared market and away from bilateral. Managing, pledging and re-using collateral when facing a central counterparty (CCPs) is a different, more complex challenge than doing so whilst facing off to bilateral counterparties. There is greater sensitivity around timely execution of activities, more intra-day activity and more restrictions on recycling high-quality collateral.
Other trends include collaborative agreements with utilities, service providers, cloud providers and tokenised settlement practices.
Has there been any impact yet from the growing clamour to adhere to ESG?
Daniel: This is starting to bubble through and will continue to gain pace. Whenever there is a restriction in the assets available (whether through choice or not), this will place greater demands on those assets available that fit into the environmental, social and governance (ESG) ethos.
With that in mind, it will require effort to put any non-standard arrangements in place. It will also require agreements regarding what is considered ‘ESG’ for each party - and how this is reflected on internal systems so that ESG acceptable collateral can be flagged and accepted in a timely manner, particularly as we move into a future characterised by faster, more automated optimisation and collateral flows.
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