FSB targets collateral rehypothecation and reuse
30 January 2017 Basel
Image: Shutterstock
There is no immediate need to harmonise regulatory approaches toward collateral rehypothecation, but reuse needs to be monitored on a global level, according to two new reports from the Financial Stability Board (FSB).
The FSB’s reports, released on 25 January, assessed the potential risks of rehypothecation and reuse to the financial system.
The rehypothecation report revealed that all of the regulatory approaches that the FSB assessed are designed to protect rehypothecated client assets within their jurisdictions, while market participants such as prime brokers have significantly strengthened their risk management practices.
While there is no immediate need to harmonise regulatory approaches, the FSB recommended implementation of Recommendation 7 from its 2013 shadow banking risks in securities lending and repo policy framework.
Under the recommendation, regulatory authorities should ensure that financial intermediaries provide sufficient disclosure to clients in relation to rehypothecation of assets so that they can understand their exposures in the event of a failure of the intermediary.
Also, when client assets are rehypothecated for the purpose of financing client long positions and covering short positions, they should not be rehypothecated for the purpose of financing the own-account activities of the intermediary.
Finally, only entities subject to adequate regulation of liquidity risk should be allowed to engage in the rehypothecation of client assets.
The FSB’s report on collateral reuse was more critical, with regulators lacking a clear understanding of global collateral re-use activities in the securities financing markets.
“The FSB considers that appropriately monitoring collateral reuse at the global level will be an important step towards obtaining a clearer understanding,” according to its statement on the reports.
This “reaffirms the importance” of implementing the FSB’s standards and processes for global securities financing data collection and aggregation, which were published in November 2015.
“[They] will now include data elements related to a non-cash collateral reuse measure and to some associated indicators (ie, metrics).”
According to the FSB’s collateral reuse report, data collection and aggregation will be restricted to collateral received and subsequently reused in securities finance transactions.
The FSB explained: “Most comments received from market participants shared the view that this is a meaningful basis for measuring collateral reuse. The scope of collateral reuse being measured is therefore restricted to collateral received and subsequently reused in securities finance transactions. However, authorities are encouraged to consider monitoring collateral reuse activities beyond securities financing transactions as appropriate.”
An approximate measure will be used to gather collateral reuse data, as “market practice is generally aligned with the assumptions behind [it]”.
“Market participants do not generally distinguish between own securities or securities originating from another collateralised transaction when posting collateral,” the FSB explained in its collateral reuse report. “Respondents also highlighted that it would be extremely difficult to extract the information needed to compute the exact measure and indicated that the indirect approximate measure may lead to over-estimating collateral reuse.”
Metrics will include collateral reuse at the jurisdiction and global level, reuse rate, the share of reused collateral, the concentration of reuse activities, the collateral circulation length, and the collateral multiplier, which constitutes a measure of velocity, but that will be at the global level only.
The FSB has started work on the detailed operational arrangements to initiate the official data collection and aggregation at the end of 2018. Data related to collateral reuse will be transmitted to the FSB for global aggregation from January 2020.
The FSB’s reports, released on 25 January, assessed the potential risks of rehypothecation and reuse to the financial system.
The rehypothecation report revealed that all of the regulatory approaches that the FSB assessed are designed to protect rehypothecated client assets within their jurisdictions, while market participants such as prime brokers have significantly strengthened their risk management practices.
While there is no immediate need to harmonise regulatory approaches, the FSB recommended implementation of Recommendation 7 from its 2013 shadow banking risks in securities lending and repo policy framework.
Under the recommendation, regulatory authorities should ensure that financial intermediaries provide sufficient disclosure to clients in relation to rehypothecation of assets so that they can understand their exposures in the event of a failure of the intermediary.
Also, when client assets are rehypothecated for the purpose of financing client long positions and covering short positions, they should not be rehypothecated for the purpose of financing the own-account activities of the intermediary.
Finally, only entities subject to adequate regulation of liquidity risk should be allowed to engage in the rehypothecation of client assets.
The FSB’s report on collateral reuse was more critical, with regulators lacking a clear understanding of global collateral re-use activities in the securities financing markets.
“The FSB considers that appropriately monitoring collateral reuse at the global level will be an important step towards obtaining a clearer understanding,” according to its statement on the reports.
This “reaffirms the importance” of implementing the FSB’s standards and processes for global securities financing data collection and aggregation, which were published in November 2015.
“[They] will now include data elements related to a non-cash collateral reuse measure and to some associated indicators (ie, metrics).”
According to the FSB’s collateral reuse report, data collection and aggregation will be restricted to collateral received and subsequently reused in securities finance transactions.
The FSB explained: “Most comments received from market participants shared the view that this is a meaningful basis for measuring collateral reuse. The scope of collateral reuse being measured is therefore restricted to collateral received and subsequently reused in securities finance transactions. However, authorities are encouraged to consider monitoring collateral reuse activities beyond securities financing transactions as appropriate.”
An approximate measure will be used to gather collateral reuse data, as “market practice is generally aligned with the assumptions behind [it]”.
“Market participants do not generally distinguish between own securities or securities originating from another collateralised transaction when posting collateral,” the FSB explained in its collateral reuse report. “Respondents also highlighted that it would be extremely difficult to extract the information needed to compute the exact measure and indicated that the indirect approximate measure may lead to over-estimating collateral reuse.”
Metrics will include collateral reuse at the jurisdiction and global level, reuse rate, the share of reused collateral, the concentration of reuse activities, the collateral circulation length, and the collateral multiplier, which constitutes a measure of velocity, but that will be at the global level only.
The FSB has started work on the detailed operational arrangements to initiate the official data collection and aggregation at the end of 2018. Data related to collateral reuse will be transmitted to the FSB for global aggregation from January 2020.
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