What happens when SEC Rule 15c3-3 changes?
04 Febuary 2020
J.P. Morgan offers a glimpse into triparty adoption for non-cash collateral in US agency securities lending
Image: Shutterstock
In US securities lending, a significant portion of the market can only post US treasurys and certain agencies (Fed collateral) as non-cash collateral, for reasons that include regulatory constraints such as those imposed by Rule 15c3-3.
Additionally, in the US non-cash collateralisation of securities lending transactions has traditionally been managed bilaterally, whereas triparty has become the norm for these transactions in most other global locations.
The bilateral collateralisation process for cash and Fed collateral is relatively manageable due to their straightforward nature. However, if equities collateral becomes eligible and widely used, the US market may follow other major markets and see both a significant increase in non-cash collateral (vs cash) and a significant shift from traditionally-used Fed collateral to equities.
The opportunity is sizable
Globally, approximately 60 percent of equity stock-loans and 72 percent of government bond borrows are versus non-cash collateral.
In North America today, 47 percent of equity stock loans are collateralized with non-cash.
In the secured financing markets outside of the US about $1 trillion in equity securities is being used to collateralize triparty activity. Furthermore, today more than $125 billion of equities are used to collateralize US triparty repo.
This demonstrates both the adoption rate of equities as collateral for stock borrows in Europe and the ability to support equity collateral via the triparty model in the US. The numbers clearly illustrate the opportunity to do more equities-based collateralisation if and when the 15c3-3 rule changes.
Adoption of equities as collateral has clear challenges. Specifically, managing equities collateral bilaterally can become operationally cumbersome and inefficient for both the borrower and lender, making it difficult to scale.
A different model could make a difference
Triparty collateral management addresses those operational inefficiencies, offering sophisticated eligibility tests that are automated, dynamic and provide efficient processing. It’s a proven model as other global markets primarily use tri-party to collateralise using equities with considerable scale.
Indicating the increasing comfort with this model, we are seeing more interest from US participants in using triparty to collateralise stock borrow activity with Fed-eligible securities and have seen migrations from bilateral to triparty as a result. Once equities can be used in US securities lending, the proven efficiencies of triparty will be available to market participants.
Getting ready
Ahead of any potential regulatory change, it’s best to understand your options. Some of the key features of triparty are outlined here so that impacted market participants can become more familiar with the structure and consider how triparty could be integrated into existing operating models.
If you currently manage any of your collateral activity bilaterally, you know that you have to independently optimise and deliver eligible collateral (with haircuts) to each counterparty (figure 1). During the life of the trade, assets need to be revalued, and further deliveries/receives to/from counterparties need to be managed. The added complexity of managing equities – if and when the rule changes – which have intricate eligibility requirements (typically using indices, issuer limits, trading volume tests as well as other concentration limits) makes supporting equities collateral bilaterally a cumbersome process.
In triparty (figure 2, overleaf), assets are held in a central long box (across asset classes and markets) governed by a master collateral services agreement. Securities can be deployed from that long box as collateral against a variety of different collateral obligations – repo, securities lending, cleared/over-the-counter margin, and collateralised commercial paper programmes to name a few – all through book transfer movements at the triparty agent, which are not subject to market cut-offs. Collateral is ring-fenced in accounts at the triparty agent governed by the program agreement between the trading counterparties and the agent. Once the collateral provider delivers available assets to the long box, the agent ensures the optimal allocation of their collateral across the trading portfolio, adherence to complex counterparty eligibility requirements and top-up of short accounts using available long box assets. This frees the collateral provider to focus on their client needs and trading book and allows the collateral taker to deliver the loaned securities. In the event, there is insufficient collateral in the long box, the triparty agent will reach out to the collateral provider. Triparty agents also support the re-use (not pictured) of received collateral against other counterparties.
Integrating US and global activity
As mentioned earlier, many global institutions are already using triparty to manage equity collateralisation in other parts of the world. For those firms, integrating the US book is simple. At J.P. Morgan, Collateral Central is a single, global platform that provides one user interface, long box and underlying operating model. That means that US and international triparty activity are managed holistically, allowing institutions to optimise the use of securities across the entire portfolio. Significant efficiencies and scalability allow market participants to concentrate on managing their firm’s financing and liquidity demands.
Firms that are new to triparty can benefit from a model that mitigates counterparty and credit risk while delivering those same operational benefits and scalability. Since securities lending is only one of the many transaction types that can be supported by triparty, the benefits only increase as and when your activity broadens or increases.
Additionally, in the US non-cash collateralisation of securities lending transactions has traditionally been managed bilaterally, whereas triparty has become the norm for these transactions in most other global locations.
The bilateral collateralisation process for cash and Fed collateral is relatively manageable due to their straightforward nature. However, if equities collateral becomes eligible and widely used, the US market may follow other major markets and see both a significant increase in non-cash collateral (vs cash) and a significant shift from traditionally-used Fed collateral to equities.
The opportunity is sizable
Globally, approximately 60 percent of equity stock-loans and 72 percent of government bond borrows are versus non-cash collateral.
In North America today, 47 percent of equity stock loans are collateralized with non-cash.
In the secured financing markets outside of the US about $1 trillion in equity securities is being used to collateralize triparty activity. Furthermore, today more than $125 billion of equities are used to collateralize US triparty repo.
This demonstrates both the adoption rate of equities as collateral for stock borrows in Europe and the ability to support equity collateral via the triparty model in the US. The numbers clearly illustrate the opportunity to do more equities-based collateralisation if and when the 15c3-3 rule changes.
Adoption of equities as collateral has clear challenges. Specifically, managing equities collateral bilaterally can become operationally cumbersome and inefficient for both the borrower and lender, making it difficult to scale.
A different model could make a difference
Triparty collateral management addresses those operational inefficiencies, offering sophisticated eligibility tests that are automated, dynamic and provide efficient processing. It’s a proven model as other global markets primarily use tri-party to collateralise using equities with considerable scale.
Indicating the increasing comfort with this model, we are seeing more interest from US participants in using triparty to collateralise stock borrow activity with Fed-eligible securities and have seen migrations from bilateral to triparty as a result. Once equities can be used in US securities lending, the proven efficiencies of triparty will be available to market participants.
Getting ready
Ahead of any potential regulatory change, it’s best to understand your options. Some of the key features of triparty are outlined here so that impacted market participants can become more familiar with the structure and consider how triparty could be integrated into existing operating models.
If you currently manage any of your collateral activity bilaterally, you know that you have to independently optimise and deliver eligible collateral (with haircuts) to each counterparty (figure 1). During the life of the trade, assets need to be revalued, and further deliveries/receives to/from counterparties need to be managed. The added complexity of managing equities – if and when the rule changes – which have intricate eligibility requirements (typically using indices, issuer limits, trading volume tests as well as other concentration limits) makes supporting equities collateral bilaterally a cumbersome process.
In triparty (figure 2, overleaf), assets are held in a central long box (across asset classes and markets) governed by a master collateral services agreement. Securities can be deployed from that long box as collateral against a variety of different collateral obligations – repo, securities lending, cleared/over-the-counter margin, and collateralised commercial paper programmes to name a few – all through book transfer movements at the triparty agent, which are not subject to market cut-offs. Collateral is ring-fenced in accounts at the triparty agent governed by the program agreement between the trading counterparties and the agent. Once the collateral provider delivers available assets to the long box, the agent ensures the optimal allocation of their collateral across the trading portfolio, adherence to complex counterparty eligibility requirements and top-up of short accounts using available long box assets. This frees the collateral provider to focus on their client needs and trading book and allows the collateral taker to deliver the loaned securities. In the event, there is insufficient collateral in the long box, the triparty agent will reach out to the collateral provider. Triparty agents also support the re-use (not pictured) of received collateral against other counterparties.
Integrating US and global activity
As mentioned earlier, many global institutions are already using triparty to manage equity collateralisation in other parts of the world. For those firms, integrating the US book is simple. At J.P. Morgan, Collateral Central is a single, global platform that provides one user interface, long box and underlying operating model. That means that US and international triparty activity are managed holistically, allowing institutions to optimise the use of securities across the entire portfolio. Significant efficiencies and scalability allow market participants to concentrate on managing their firm’s financing and liquidity demands.
Firms that are new to triparty can benefit from a model that mitigates counterparty and credit risk while delivering those same operational benefits and scalability. Since securities lending is only one of the many transaction types that can be supported by triparty, the benefits only increase as and when your activity broadens or increases.
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