If there is one common theme among the numerous conferences and in recent research studies on the securities lending industry, it is that high quality collateral is getting scarcer and more costly.
There are well-known regulatory and industry dynamics contributing to this situation: sovereign downgrades, increasing demands for secured loans as a result of understandable risk aversion, the looming Basel III liquidity ratio regime, the push to OTC clearing, the list goes on.
SLT: Can you tell me about Clearstream’s global collateral management partnerships?
Stefan Lepp: We have roughly 20 years of experience in the collateral management space and we decided to offer this know-how and our system to third parties. In July 2011, the Brazilian CSD CETIP was the first infrastructure to go live with our collateral management outsourcing service. Since then, Australian ASX Group and Strate, the South African CSD, have signed an agreement with us targeting the launch of such service for their domestic market. The goal of this cooperation is to enable our partners in supporting their domestic customer base in collateralising, for example lending positions on a completely automated basis. Initially, the whole setup is domestic: Local banks can cover their domestic exposures with domestic assets. But in the second phase of the partnership – which we have started with CETIP – they can also combine assets in the home market with international assets that they have with Clearstream. So it will be a combined and much larger liquidity pool which will put our partners in a position to cover exposures of their customers in the domestic market. This reduces over-collateralisation significantly as they can go for the “cheapest to collateral”. And as fragmentation is decreased, opportunity costs will be brought down increasing the efficiency in the back office of our partners’ customers.
SLT: You are also trying to increase the kind of assets that can be accepted as collateral, can you tell me more about that?
Lepp: As collateral is a scarce resource, we are constantly looking for assets which we can make collateral-eligible. Investment fund shares are an example: we are looking into introducing selected money market funds as collateral with substantial turnover and daily market prices, so they can be evaluated properly. We have also introduced equities for a triparty collateral solution – and now, too, for securities lending.
We are also working with DTCC to investigate to use registering bilateral loans as collateral. DTCC is very active on syndicated loans, but there is very little you can do with them. It’s actually paper that remains immobilised in the vaults and gathers dust. We want to mobilise this dormant paper and this comes back to the idea of widening the range of segments to be used as collateral.
First, the loans are registered, initially in the US and then in Europe. For example, a $10 million interbank loan with a three-year term results in such document; what we are doing is registering this paper in the system and once it is registered, it can be administrated.
This leads to balance sheet relief but also, if it is identified with, for example a kind of ISIN, it could be treated in a similar way as, for example Eurobonds. Then the question is: how do you value such a document? That is what we are working on right now. We need to have a clear, transparent and pragmatic approach in terms of operational processing, which is accepted by the industry.
So next to equities and investment funds, we might have these bank loans, which is potential collateral , but right now is lying dormant in the vaults of global financial institutions.
We expect to have the loans ready for registration and administration in 2013, but in terms of being eligible for collateral, we will need regulatory approval, market commitment and a clear logic for valuation – so that will take a bit longer.
I believe the market is ready for this. Quality collateral is drying up, which makes such a product that makes collateral available from dormant paper highly welcomed.
SLT: Apart from a wider variety of collateral, you are also working on “dispatching” it more effectively. Can you tell me about the process?
Lepp: That brings me back to CETIP. Our partners originally approached us with the request to develop a system, which can allocate collateral to cover exposures in their domestic market. They realised that developing their own system would take a long time, so it really came down to a time-to-market and a cost issue for them. We have been able to come up with a model that fits their requirements as the domestic assets don’t leave Brazil. Soon after, we announced a partnership with ASX in Australia and just recently with Strate in South Africa too. I am convinced that more markets will follow this model. Although each market has different business drivers and needs, at the end of the day, the overall idea is always the same: optimising the use of collateral.
What differentiates us from other service providers in the collateral management space is that we allow the securities they allocate as collateral to stay in their domestic environment. We have understood that there are markets out there which are simply not in a position to transfer domestic bonds out of their home market for regulatory, political or efficiency reasons. The assets have to stay in the local market.
So we said, ‘OK, if the collateral cannot come to us, then we go to the collateral’. And we developed the functionality to allow these domestic infrastructure providers to keep all the assets in their home market under local regulations, terms and conditions. Clearstream does not even have to appear as a service provider; we perform the allocation algorithms in the background and provide the respective settlement instructions.
The model we have developed for our strategic partnerships strengthens their local markets because we are not demanding the transfer out of domestic assets. This is why regulators are very much in favour of this model.
The phase we are currently working on with CETIP is to add, next to domestic portfolios, international assets of their underlying customers to cover domestic exposures. Our system at Clearstream has the intelligence to look across the accounts at CETIP and Clearstream in order to determine the cheapest to collateral on an optimised basis.
The next phase we are working on right now is to support the Brazilian market in covering global exposures because these banks are also active with clearing houses all over the world. Right now, there is constant over-collateralisation in different locations to be prepared for peaks. According to a recent Accenture study, this over-collateralisation and the resulting inefficiency costs some €4 billion to the industry on an annual basis. We are building more links to CCPs, to clearing houses, stock exchanges and trading platforms to act on a “power of attorney” basis so that we can transfer collateral quickly. On top of that, we built links with central banks across the globe to give our customer streamlined access to central bank money, which is key for almost all of our customers.
SLT: How exactly could this impact the securities lending industry?
Lepp: The situation is very similar. In some markets, customers have assets with a CSD while in others they hold the assets with an agent bank. Clearstream has a model in place which allows its customers to keep those assets in the same place but with the benefits of collateral management. Going forward, market infrastructures which we are partnering with can collateralise lending positions on a completely automated basis.
SLT: That seems like a lot of paper flying around a lot of places. What does risk management look like, particularly as you diversify collateral type?
Lepp: The residing risk is not something that Clearstream will take control over because we are not the risk manager of the underlying transaction. A CCP would never outsource this function, so our partners stay in charge of risk estimation and management. They simply tell us: what is the exposure and how should it be collateralised? And then we will help them.
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