Evidence on whether the collateral transformation trade is slowly grinding to life (Finadium subscribers only)

Some recent news and comments point to indications of how far the collateral transformation trade has moved forward, and what look to be its prospects over the next year.

We’ve seen several articles and commentaries over the last few days that suggest that the collateral transformation trade is moving forward in some parts of the world but not others. Ultimately we expect that collateral transformations will affect most every corner of securities lending, repo and OTC derivatives, but the drive forward is slow. Here’s the evidence in front of us:

– Saheed Awan, head of Euroclear’s Collateral Highway, writing in the FTSE, said that “lenders have resorted to asking for, and getting, more complex collateral schedules as an alternative to receiving highly rated securities collateral to secure their loans. As an illustration of how this complexity has grown over the past few years, Euroclear’s global ­Collateral Highway allows users to set their eligibility criteria from amongst 210 different rules (up from 100 rules pre-crisis) on concentration limits, ratings and a host of other ­attributes—testament to the fact that risk managers now call the shots at most firms.”
Euroclear’s data show the average daily value of collateral outstanding rising from EUR700 billion in 2012 to EUR787 billion in Q2 2013. Our guess is that the figure is in the EUR800-850 billion range now.
– In a recent interview with the FT, Chris Topple from Newedge noted at the end how his Agency Cash Management (ACM) service had just incorporated as an ATS in the US. This service provides an exchange-type of mechanism to match cash providers and repo issuers. Mr. Topple noted that “the idea is to launch it into the US market and seek a partnership with a tripartite agent in the US as well to kick it off.” We aren’t entirely sure which US triparty agent will go for this, but Newedge clearly thinks there is an opportunity. Maybe this is the day when a third US triparty agent gets in the game to support ACM.
– In its October 15 2013 Securities Markets Risk Outlook, IOSCO, citing a European Central Bank survey from July 2013, said that there was “an increase in the supply of collateral swaps by non-bank counterparties such as insurance companies, investment funds, pension plans and other institutional investment pools.”
– The same September 2013 ECB survey, showed that by and large, demand for funding had decreased a bit (except for a few well known categories) and that the collateral markets were functioning well overall (no change or improvement in liquidity). The numbers vary a bit by collateral types but there are no big changes to report here.
– IOSCO also noted a December 2012 Federal Reserve SCOOS survey saying that collateral transformation trades were about flat in the US; we think this is still about right. Two months ago we would have said that transformations were percolating along, but a recent withdrawal by a big borrower suggests that US non-cash loans were down overall in Q3 2013.
– Big US agent lender revenues were down in Q3 2013 across the board, the result of both annual lulls in lending activity, historically low interest rates and structural change in the markets. Not much collateral transformation to report there.

Here’s our take: we’re not ready to declare collateral transformations a victorious business model yet but we do think there is gathering momentum for this long-discussed opportunity to generate real opportunity. We’re seeing the beginnings of change in Europe while US borrowers still can rest on their non-Basel III laurels for another year or two. But as we said in our December 2012 report on the topic (Sizing Up the Collateral Transformation Trade), collateral transformations remain an important space to watch.

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