With collateral being at the heart of regulatory efforts to reduce complexity, banks find themselves needing to change organizational structures. But how internal desks will ultimately end up designed is both a regulatory and business consideration, said speakers at a recent meeting in London, who also shared the trials and successes of efforts to make collateral management efficient as an essential service.
One major bank headquartered in Europe has decided to take a centralized approach, with some space for granularity. The bank’s collateral manager said the plan is to set up a central collateral desk across all the legal entities, that will interact with the Treasury for liquidity. The Treasury will charge the business units for the collateral needed for the “buffer requirement” created by transactions. Moreover, the central collateral desk can reconstruct the trade, or do another lower cost trade. It’s a mentality that is a big departure from traditional approaches.
“You can choose whether or not you want to own the balance sheet usage of (the trade), or you want to pay away from that. Because in the old world, if you told people that they were going to make 70 basis points and they were going to be using a billion worth of balance sheet, they were going to take that trade. But in the new world you would tell them how much they are actually getting charged (and) they might say you know what, you take the whole thing. That means that central desk will be sitting with all the requirements and all the needs, and they are going to be able to match businesses up that never talked to each other before because both parties get a better deal,” he explained.
This approach is not without its major complications, particularly when it comes to the issue of: who pays? “One of the things which is probably the most difficult bit to get agreement across, though we technically have broken down silos, and put everything into a global markets division – so there should be no difference between fixed income and equities any more – (is) these issues around business model,” he said.
Transfer pricing, he added, is the key to making it work. But giving authority to the Treasury to do it is viewed as being “problematic”, he added: “You need somebody who is neutral, and if you make them a profit centre, they cease to be neutral. So that part of the discussion with us has been parked at the moment.” However, getting buy in while implementing is made easier when the underlying data is available, which can pinpoint the exact location that, for example, LCR requirements are coming from. “You are able to show that those are the right returns rather than getting into this usual dogfight about no, it’s too expensive. Well it’s not too expensive if there’s someone else in the firm that is providing that price and they are willing to take that other side,” he said.
One of the mid-sized European banks, which also has a centralized desk structure, said that the most challenging aspect with cost transfer pricing has been evidencing non-profitable business models. “Those discussions get really nasty,” he said. “To say: well, when I add up all those factors, I am sorry but the prices you charge your client and the business you have, it’s not profitable.”
Part of the solution for the bank has been to send “lots” of business to CCPs, though he admits that he has a “split” mind because of the “tremendous” risk the infrastructures manage. “Hundreds of billions of exposures that CCPs have to manage, but we don’t have 100 CCPs in Europe, we have just two or three, and you have to ask the question: which exposure would you like to have? Everybody’s one CCP? Or with 500 different kinds of clients with different types of trading?”
A UK-headquartered bank said that one solution could be to charge clients on a fixed fee basis rather than within a trading model. At the moment, there’s also a major push to get clients to move to cash CSAs to reduce the leverage and net stable funding ratios. The big question, said a member of the bank’s capital and collateral optimization team, is whether the repo market is going to have the capacity to transform the collateral.
“You’ve got counterparties that just hold bonds, and you are telling them you want them to move to cash-only. Are they going to liquidate those bonds? Are they going to leave the repo market?” she said. “It doesn’t make any sense that you are asking counterparties that have bonds to move to cash but you can’t also give them the balance sheet in terms of the repo facility.” She added that there are ongoing discussions about moving the repo business outside of the banking sector in favour of more peer-to-peer lending.
One bank located in the Nordic and Baltic areas has not moved towards a centralized desk model, opting instead for a “virtual pool” of allowable collateral assets. The onus will then be on the collateral optimizer to look through all the eligibility sets, and suggest an allocation from the pool of virtual collateral inventory. The next step would be to implement the suggested trades, and the bank is relying on an automated STP function yet to be built for efficiency on this front.
It means that the current organization structure can be maintained, the bank’s chief dealer said. “We are still going to have an equity finance desk, fixed income liquidity desk, fixed income repo desk, treasury desk…we believe that can still work provided we have an optimizer that can do the leg work for us.” Currently the cost of collateralizing does not hit the end trader directly, he added. The bank is keen to change that, and its partnering vendors will be able to calculate the cost per counterparty unit. “That real cost, we want to give that back to the exposure generators, and equally, if it’s a profit, they get the profit.”
