Under pressure
16 August 2022
Carmella Haswell speaks to Ernst Dolce, head of liquidity solutions at AXA Investment Managers, on the mounting pressures facing markets and the firm’s top priorities
Image: Ernst Dolce
Changes in the market and the regulatory landscape are putting pressure on the global demand for high-quality liquid assets (HQLA) collateral, according to Ernst Dolce.
Currently, the market is facing high inflation pressures as the consumer price index (CPI) reached 9 per cent for the US and UK, 6.1 per cent for France, 7.5 per cent for Germany and 10 per cent for Spain in July. The market is also facing interest rate hikes, or an anticipation of future interest rate hikes, explains Dolce, and an increase of year-to-date market volatility.
Dolce indicates: “Some market participants, due to the decrease of the value of the assets usually used as collateral, and an increase in their margin calls, are facing more pressure than others to post more collateral for derivatives, repo, securities lending transactions, or to manage their regulatory solvency ratio or liquidity ratio — short and long term.”
The introduction of the requirement to post initial margin for uncleared derivatives has contributed to a reduction in the inventory of collateral available. With Phase 6 of the Uncleared Margin Rules (UMR) to go live in September 2022, an increasing number of asset managers — not captured by Phase 5 of the UMR regulation — will have to deal with the reduction of the available collateral pool.
“The combined effect of the changes in the markets and the regulatory requirements are pushing market participants to quickly modify their cash management, liquidity sourcing, optimise their collateral management and increase the monetisation of any excess of liquidity, where feasible.” Dolce explains.
He adds: “We expect the high demand for HQLA and corporate bonds to prevail this year due to market conditions and the regulatory landscape, as well as an increasing interest from clients for securities financing.”
To understand the drivers of growth and demand for a firm's securities financing programme, it is necessary to look at the mismatch between the supply and demand for liquidity, changes in the markets, and the impact of the regulatory landscape.
The mismatch between the supply and demand for liquidity can be illustrated by the injection of liquidity in the markets by the central banks to cope with potential financial impacts of the COVID crisis — which has contributed to an abundance of liquidity in the market, according to Dolce. European Central Bank excess liquidity reached €4.4 trillion as of 3 August 2022, compared to €1.6 trillion on 1 January 2020. However, this excess liquidity is available only to banks or institutions with market-making commitment.
Further evidence of this mismatch could be illustrated by the fact that the liquidity available within the Undertakings for the Collective Investment in Transferable Securities (UCITS) and Alternative Investment Funds (AIFs) remains underused or inaccessible without the ‘middle-man’ role of banks, broker-dealers and agent lenders for some market participants with liquidity needs.
The European Fund and Asset Management Association registered €20.8 trillion of net assets of investment within the UCITs and AIFs domiciled in Europe in the third quarter of 2021.
Building blocks
Dolce indicates that securities finance is a tool for AXA IM to create liquidity solutions, optimise collateral management across derivatives, repo, reverse repo and securities lending, reduce counterparty exposure, in addition to source funding and generate income. “Our strategy is to look at these building blocks to provide better liquidity management to our clients,” says Dolce.
He adds: “We are continually adapting this tool to address the needs and constraints of our clients. The way we apply this tool to UCITS, alternative investment funds, pension funds, insurance companies, and the client’s balance sheet is highly driven by regulatory and client requirements.”
Increasing automation and improving operational and legal frameworks has become a top priority for AXA IM. The finance industry has been journeying toward the implementation of automation, with AXA IM being no exception as the firm pinpoints securities financing transactions and collateral management as a main focus for automation.
Automation allows AXA IM to reduce the cost of implementing securities lending and to reduce pressure on collateral management. “We are trying to automate our strategy to capture more trades in the market. We strongly believe that a significant part of the general collateral transactions — e.g., open and term transactions — should be executed on platforms,” says Dolce.
In terms of improving its operational and legal frameworks, the firm will implement two main plans of action. Firstly, AXA IM is expected to set up additional triparty agent services as principal and agent lenders to manage the collateral. The firm will also be working hand-in-hand with triparty agents to accelerate the Know Your Customer (KYC) onboarding process. “We believe that a more standardised onboarding process at triparty agents will benefit the market participants, accelerate the onboarding process as well as accelerating our ability to serve our clients,” explains Dolce.
Secondly, AXA IM will encourage increased connectivity between third-party vendor applications and the development of APIs by these vendors. The securities financing market infrastructure will evolve through to higher demand from all market participants for cloud-based solutions and API connectivity.
Voting rights
Speaking to SFT, Dolce touches upon AXA IM’s relationship with environmental, social and governance (ESG) principles, a topic that has become an integral part of discussion for firms. “We want to continue to perform the securities financing activity with a robust responsible investment policy and maintain our stewardship in the industry,” Dolce projects. This includes complying with the set of clients and internal ESG guidelines: voting rights, screening of collateral, and restriction on assets lent out.
Regarding voting rights when performing securities lending, AXA IM’s policy is to use all commercially reasonable efforts to recall all positions on loan when there is an opportunity to vote.
Beyond exercising their voting rights, AXA IM acknowledges that clients may seek to implement additional ESG guidelines on both legs of the securities lending transaction. For example, restrictions on assets lent out could be implemented by putting guidelines on the lendable assets and restricting the eligible collateral.
Dolce adds: “It is fair to say that the screening of the collateral received requires new tools or the adaption of existing ones in order to capture the ESG guidelines of clients. This is an operational issue that could be fixed by all market participants and not a challenge specific to ESG.
“ESG and securities financing are compatible and we all — clients, regulators and market participants — have a role to play to ensure strong stewardship and a commitment to responsible investments, clarity in the regulatory framework and building the infrastructure to support and shape securities financing collateral management.”
Next steps
Looking ahead, AXA IM’s focus over the coming 12 months will remain on optimising collateral management across derivatives, repo, reverse repo and securities lending transactions. Dolce indicates a substantial added value for clients, including lower collateral management cost and an increase in income generation, when using securities financing techniques and designing liquidity solutions.
Additional next steps for the firm include increasing the automation of trading activity, such as increasing the volume of low touch transactions, and building intelligent tools and data analytics to better serve AXA IM clients
Currently, the market is facing high inflation pressures as the consumer price index (CPI) reached 9 per cent for the US and UK, 6.1 per cent for France, 7.5 per cent for Germany and 10 per cent for Spain in July. The market is also facing interest rate hikes, or an anticipation of future interest rate hikes, explains Dolce, and an increase of year-to-date market volatility.
Dolce indicates: “Some market participants, due to the decrease of the value of the assets usually used as collateral, and an increase in their margin calls, are facing more pressure than others to post more collateral for derivatives, repo, securities lending transactions, or to manage their regulatory solvency ratio or liquidity ratio — short and long term.”
The introduction of the requirement to post initial margin for uncleared derivatives has contributed to a reduction in the inventory of collateral available. With Phase 6 of the Uncleared Margin Rules (UMR) to go live in September 2022, an increasing number of asset managers — not captured by Phase 5 of the UMR regulation — will have to deal with the reduction of the available collateral pool.
“The combined effect of the changes in the markets and the regulatory requirements are pushing market participants to quickly modify their cash management, liquidity sourcing, optimise their collateral management and increase the monetisation of any excess of liquidity, where feasible.” Dolce explains.
He adds: “We expect the high demand for HQLA and corporate bonds to prevail this year due to market conditions and the regulatory landscape, as well as an increasing interest from clients for securities financing.”
To understand the drivers of growth and demand for a firm's securities financing programme, it is necessary to look at the mismatch between the supply and demand for liquidity, changes in the markets, and the impact of the regulatory landscape.
The mismatch between the supply and demand for liquidity can be illustrated by the injection of liquidity in the markets by the central banks to cope with potential financial impacts of the COVID crisis — which has contributed to an abundance of liquidity in the market, according to Dolce. European Central Bank excess liquidity reached €4.4 trillion as of 3 August 2022, compared to €1.6 trillion on 1 January 2020. However, this excess liquidity is available only to banks or institutions with market-making commitment.
Further evidence of this mismatch could be illustrated by the fact that the liquidity available within the Undertakings for the Collective Investment in Transferable Securities (UCITS) and Alternative Investment Funds (AIFs) remains underused or inaccessible without the ‘middle-man’ role of banks, broker-dealers and agent lenders for some market participants with liquidity needs.
The European Fund and Asset Management Association registered €20.8 trillion of net assets of investment within the UCITs and AIFs domiciled in Europe in the third quarter of 2021.
Building blocks
Dolce indicates that securities finance is a tool for AXA IM to create liquidity solutions, optimise collateral management across derivatives, repo, reverse repo and securities lending, reduce counterparty exposure, in addition to source funding and generate income. “Our strategy is to look at these building blocks to provide better liquidity management to our clients,” says Dolce.
He adds: “We are continually adapting this tool to address the needs and constraints of our clients. The way we apply this tool to UCITS, alternative investment funds, pension funds, insurance companies, and the client’s balance sheet is highly driven by regulatory and client requirements.”
Increasing automation and improving operational and legal frameworks has become a top priority for AXA IM. The finance industry has been journeying toward the implementation of automation, with AXA IM being no exception as the firm pinpoints securities financing transactions and collateral management as a main focus for automation.
Automation allows AXA IM to reduce the cost of implementing securities lending and to reduce pressure on collateral management. “We are trying to automate our strategy to capture more trades in the market. We strongly believe that a significant part of the general collateral transactions — e.g., open and term transactions — should be executed on platforms,” says Dolce.
In terms of improving its operational and legal frameworks, the firm will implement two main plans of action. Firstly, AXA IM is expected to set up additional triparty agent services as principal and agent lenders to manage the collateral. The firm will also be working hand-in-hand with triparty agents to accelerate the Know Your Customer (KYC) onboarding process. “We believe that a more standardised onboarding process at triparty agents will benefit the market participants, accelerate the onboarding process as well as accelerating our ability to serve our clients,” explains Dolce.
Secondly, AXA IM will encourage increased connectivity between third-party vendor applications and the development of APIs by these vendors. The securities financing market infrastructure will evolve through to higher demand from all market participants for cloud-based solutions and API connectivity.
Voting rights
Speaking to SFT, Dolce touches upon AXA IM’s relationship with environmental, social and governance (ESG) principles, a topic that has become an integral part of discussion for firms. “We want to continue to perform the securities financing activity with a robust responsible investment policy and maintain our stewardship in the industry,” Dolce projects. This includes complying with the set of clients and internal ESG guidelines: voting rights, screening of collateral, and restriction on assets lent out.
Regarding voting rights when performing securities lending, AXA IM’s policy is to use all commercially reasonable efforts to recall all positions on loan when there is an opportunity to vote.
Beyond exercising their voting rights, AXA IM acknowledges that clients may seek to implement additional ESG guidelines on both legs of the securities lending transaction. For example, restrictions on assets lent out could be implemented by putting guidelines on the lendable assets and restricting the eligible collateral.
Dolce adds: “It is fair to say that the screening of the collateral received requires new tools or the adaption of existing ones in order to capture the ESG guidelines of clients. This is an operational issue that could be fixed by all market participants and not a challenge specific to ESG.
“ESG and securities financing are compatible and we all — clients, regulators and market participants — have a role to play to ensure strong stewardship and a commitment to responsible investments, clarity in the regulatory framework and building the infrastructure to support and shape securities financing collateral management.”
Next steps
Looking ahead, AXA IM’s focus over the coming 12 months will remain on optimising collateral management across derivatives, repo, reverse repo and securities lending transactions. Dolce indicates a substantial added value for clients, including lower collateral management cost and an increase in income generation, when using securities financing techniques and designing liquidity solutions.
Additional next steps for the firm include increasing the automation of trading activity, such as increasing the volume of low touch transactions, and building intelligent tools and data analytics to better serve AXA IM clients
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