The evidence looks pretty nailed down on how pension plans (plan sponsors, pension funds or pension schemes), asset managers and insurance companies all see the world of collateral management for OTC derivatives going forward over the next year or two.
The summary for pension plans is that they have enough collateral and that they plan to outsource collateral management to a custodian or other service provider. Besides our own research, a report from Northern Trust last week looked at 200 US pension plans holdings to see if they would have enough cash or government bonds to meet cleared OTC derivatives requirements. According to the report, aptly titled “Capital requirements for pension funds in the wake of Dodd-Frank,”Among the accounts in our sample, the average initial margin requirement was $5.3 million, which is only 1.53% of gross notional. Only 18% had initial margin requirements larger than $10 million. Our analysis shows that most funds in our sample group with margin requirements of more than $1 million have ample eligible collateral, in the form of high-grade government or corporate bonds, to meet their initial margin requirements.” This is no great surprise – pensions tend to be net securities lenders to the street, so really what they are doing is retaining a bit of inventory to post for their own OTC derivatives collateral needs.
On outsourcing, nearly all the US and Canadian institutions we spoke in our last big survey round said that they planned to outsource collateral management to a third party. European institutional investors were more hesitant but we suspect that many will outsource as soon as operational requirements become overly complex.
Meanwhile, asset managers and insurance companies are pretty much the reverse, more so in the US than in Europe. These funds tend to be short on cash and government bonds and heavy on equities and corporate bonds, exactly what they don’t want to have for collateral requirements. Our July 2013 survey of large OTC derivatives end-users on clearing and collateral (available here courtesy of Calypso) showed that 56% of our sample had conducted a collateral optimization exercise, but that even so the majority of firms were basically planning to wing it on collateral for the immediate future. We believe that under 20% of large asset managers and insurance companies really will have enough cash and government bonds, in the right accounts at the right times, to meet their collateral requirements. This will make them net collateral borrowers.
Just as institutional investors expect to outsource, 75% of the asset managers and insurance companies we spoke with planned to keep their collateral management activities in-house. A stark contrast.
It appears then that the battle lines of collateral are drawn. Pensions, today’s net lenders, will keep what they need and lend the rest at a premium fee to asset managers, insurance companies and others that want to post corporate bonds and equities back to them as collateral. Let the games begin.