Finadium held an event in London on Monday, September 22, entitled “Building New Business Models for Repo and Secured Funding”, hosting some 50 attendees. While some of the topics we heard were overlapping from other recent events, some new ideas came up too. Here’s a summary of what we discussed.
As an overarching theme of the last several months, it seems to us like we are in the idea generation phase of solving for new regulatory and market constraints. We saw this clearly when working on our May 2014 research report, “Emerging Technologies in Securities Finance and Collateral Management“, but the issues are not just IT related; they extend well into questions about organizational structure, legal relationships and the relative positioning and power of market participants. Sorting out these issues is really where we are at now.
The main topic of our Sept 22 event was capacity in one form or another. This topic was approached from the perspectives of new products including Eurex’s GC Repo Futures, NASDAQ’s Single Treasury Futures, Repo CCPs and collateralized commercial paper. All seem viable as a means of rebuilding capacity lost in the bilateral market but none yet have the momentum to be a one-size-fits-all solution. A critical issue is the inclusion of the buy-side. Several CCPs including the Canadian Derivatives Clearing Corporation, Eurex Clearing, DTCC and OCC have publicly stated that they are working on buy-side solutions, but only Eurex’s Lending CCP now has a solution in place. Getting the buy-side in the door in some form or another will be critical for CCPs to enable capacity. Of course, the buy-side does not want to post margin and including them is not free from a risk perspective. The costs will fall back on the sell-side. But if this is the cost for maintaining any functional market at all, it is worth taking on.
We also discussed the breakdown of silos, first between securities lending and repo and then between repo and prime brokerage, futures and other synthetic financing mechanisms. We hear more and more about securities lending and repo merging and IT vendors preparing for that eventuality. We can see a scenario where the industry finds that either securities lending (on a CCP?) or repo (also on a CCP?) is the most cost efficient means of conducing financing activity, and the market shifts in that direction almost overnight. Its no longer a conversation about regulatory arbitrage; we’re now on a conversation about regulatory directions forcing behavioral change. The upshot is that there will be continued upheavals throughout the securities finance value chain as these directions force not only behavioral change but also organizational change.
The last big topic was where central collateral funding should live within the firm. We saw more attendees thinking that repo should own central collateral funding than at our New York repo and secured funding event in June 2014, but the joke is that repo traders are the first to say that they should have control of collateral funding activities. The other option is that collateral funding be in Treasury, and option that we are not happy with as that removes the profit incentive from the transaction. One way of making this decision is whether collateral is an asset class. We think that it is, at least for now. Perhaps projections of collateral shortages will never come to pass, but even so we see collateral demands increasing as interest rates rise.
Our great thanks to sponsors SunGard and Euroclear for supporting this event, and to our speakers and attendees for engaging in the conversation. We look forward to the next time.