What are the key trends that you have observed in collateral management?
There has been a huge increased focus on collateral management from all types of organisations. Sell-side institutions lead the way, seeking to better leverage all of the assets that are available to them, and this has also had an impact on buy-side institutions that need to make best use of the assets that they are holding in order to offset risk in other transactions.
Much of the interest is driven by the increased demand for greater risk mitigation. For example, in the OTC derivatives world, the mandated move to central clearing is generating a demand for central counterparty-eligible assets. Also, on a regulatory front, the need to maintain liquidity buffers to provide greater security to financial markets in times of stress is requiring firms to manage their use of all liquid assets far more effectively.
There is also a demand to reduce costs and work more efficiently across the board, so the standardisation of processes and IT solutions is a goal for many institutions.
The increased interest in collateral management, and the introduction of the collateral upgrade/downgrade trades, has benefited the securities finance world, as this is another motivation for demand for and supply of securities lending activity.
Have the practices for cash collateral investment changed in the last two years?
Post AIG, the importance of managing the re-investment of cash collateral that is received against loans with the same stringent criteria as any other investment became crystal clear. The tightening up of cash re-investment guidelines took place more than two years ago, and in the intervening period, beneficial owners have become far more informed about how their cash collateral is deployed. Although some of the guidelines may have returned from the original ‘crisis management’ levels, collateral re-investment schedules have become more granular and restrictive, and are reviewed with greater frequency.
Typically, what are the margins and what do you think the right margins should be?
From the data that we have seen, we are aware that margins vary regionally, and in general, they are somewhat, but not startlingly, higher now than they were historically. The highest margins are—unsurprisingly—most commonly found in emerging markets.
How will all the proposed capital regulations affect collateral for securities lending?
Though there is little direct impact on securities lending trades, the need to maintain greater control of all assets, and in particular liquid assets, is driving the need for increased asset optimisation, and securities lending can be used as a vehicle to transform one type of asset holding into another. One thing is for certain, since the cost of doing business is now significantly higher than it was before, firms pay far more attention to ensuring that they are in a position to allocate the cost of capital right down to the underlying trading activity in order to allow them to judge which areas of the business are the right ones to focus on.
Are securities lending transactions delivery versus payment, or is there always a settlement exposure risk?
The answer to this depends on the market in which the transaction is settling, and of course, whether the transaction is against cash or non-cash collateral. There are some major markets that are true cash delivery versus payment, but in international markets there is greater usage of non-cash. Although initial margin is not standard in the securities lending markets, there is sometimes an agreement to pre-collateralise in order to remove settlement risk for the lender, but this is in a minority of cases.
Regarding collateral in Asia, is the market using more cash or non-cash for collateral trades, and how are trends shifting?
Asia is pre-dominantly a non-cash market, but in certain regions the usage of central counterparties (CCPs) also facilitates the use of cash collateral. From the data that we see, we are not seeing a significant shift in the type of collateral that is used.
Asia has a number of CCPs that work in the stock borrowing and lending markets (India, Malaysia, Taiwan and South Korea are the key ones).
Have these models changed in 2012?
Asia is ahead in terms of the already established CCPs in the market. For some markets, the use of a CCP is put into place as a fundamental part of establishing a new market, due to the counterparty risk mitigation and transparency benefits that they bring. Although there have been relatively subtle changes (while some are planned) in the way in which these CCPs are used (methods of access, and so on), the fundamentals have not changed.
Would you expect CCPs to change structurally as a result of regulations?
It is unlikely that CCPs will structurally change as a result of broader regulation, because while in many regions new regulation are forcing the uptake of CCP usage, they are already well established in Asia. In effect, Asia is ahead of the game in this respect.
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