As usual, the CloudMargin team attended the annual Global Funding and Financing (GFF) Summit earlier this month, and this time, our own Helen Nicol, Head of Product, represented CloudMargin on the panel Rethinking collateral management: has optimisation become a must?
The answer, not surprisingly, is yes, optimisation is a must, and all the panelists agreed.
The more interesting part of the conversation was around the why?
In the post-trade world it’s now critical to find the most efficient allocation of assets within a predefined set of constraints, including eligibility, cost, the need to identify the cheapest-to-deliver collateral, corporate actions, currency, location and fees, and the need to determine the least expensive way to deliver assets for a given agreement and protocol.
Firms are facing more challenges than ever before; scarcity of collateral, higher volumes, complex eligibility schedules and cross-border challenges are just a few of these. Compounding these challenges are the operational impact of rising interest rates, the UK’s Liability Driven Investment (LDI) problems and the inability to recall assets due to rehypothecation.
From the demand side of the equation, hedge fund positioning is the key driver of demand for scarce assets, and that positioning consumes a significant portion of broker-dealer balance sheets. Regulations have a profound impact. For instance, the Net Stable Funding Ratio (NSFR) drives many actions by dealers, along with leverage ratio, risk-weighted assets (RWA) and whether an institution is a global systemically important bank (G-SIB).
While a lot of scarce collateral is sitting with buy-and-hold investors, they alone can’t solve the collateral scarcity problem in the market because custodian banks are fully consumed in terms of capital.
Some other issues identified as presenting market challenges:
- High volatility in energy prices is also consuming significant amounts of high-quality liquid assets (HQLA).
- Brexit has contributed to dislocations as European legal entities have trapped collateral and are too thinly capitalized to help smooth dislocations.
Two potential proposals on the table to try to address the probability of dislocations:
1) Give the buy side access to the European Central Bank (ECB) balance sheet; or
2) Make it easier for banks to intermediate through relaxed capital requirements.
- Clearing may also help ease the situation. In the U.S., clearing converts a non-U.S. to a U.S. counterparty, which is important for the GSIB framework. Doing so converts a 100% risk weight to a 2% risk weight – a dramatic decline. The catch is that the dealer has to fund the margin. The market has zero haircuts while central counterparties (CCPs) have material haircuts – up to 50% for Gilt linkers. CCPs need to make progress on portfolio offsets to reduce margin requirements.
Technology solutions such as distributed ledger technology (or DLT) tokenized cash and securities will transform intraday liquidity and address the issue of failures.
While progress is being made, the general consensus was that we expect to observe and discuss the same intensity of regulatory constraints at next year’s summit.
As the industry continues to come together and discuss best practices for optimisation, one thing is critical – centralisation, connection and automation are the foundation of a sound optimisation strategy. To learn more about how CloudMargin helps firms simplify their collateral and margin management process, check out our product.