We return to the US this week after two successful events in London and Zurich, covering collateral, funding, securities lending and repo. Here’s what we learned, combining findings from both locations.
1) Equity collateral is important but not the be-all end-all. Market participants were willing to talk about equity haircuts in the 8%-15% range, even though the recent fall of Volkswagon’s share price of 30% in one day shows how volatile stock prices can be in an extreme case (although no one in their right mind would be concentrated in only one equity collateral position). No borrower will be posting 30% haircut on equities as collateral if there is any other option. There was some talk about trading off haircuts vs. rates, but we see more a question of needing to accept equities as collateral in order to get any trade done. The leverage was in how low or high the haircut would be, but not the rate. ETFs were also discussed as collateral, with the view that any structured product would bring more risk than a basket of the same underlyings.
2) Repo is not dead and new market participants are emerging. Although the European repo market has declined overall, newer players are starting to engage that may ultimately prove a better support and deconcentration of the market than what has happened before. Attendees suggested that Japanese, Chinese and Australian banks were three places to look. We see Japanese banks in particular starting to engage more. We compare the European landscape to the US, where we see extra concentration among large players increasing their books that more than offsets the volume from newer or smaller participants with balance sheet. While Special Purpose Vehicles are an interesting mechanism for brokers to get their illiquid assets off-balance sheet and provide short-term investment opportunities for hedge fund clients.
3) It is uncertain if the cost of collateral will reduce participation. Some people thought it would, with the buy-side facing sharply higher collateral costs that would need to be met either internally or through collateral transformations. Others thought that costs would not increase all that much (although there are cost increases already) so as to meaningfully reduce participation.
4) A main way to manage costs is through utilities. GlobalCollateral’s tools are one, AcadiaSoft’s are another. While these tools decrease the uniqueness of each financial institution’s services and value-add, they also serve to lower costs for all market participants. Thinking this through to a logical conclusion, if 80% of the market is sharing a commoditized utility cost while the remaining 20% are going it alone, that 20% naturally has the higher costs. Its not a good situation for remaining cost competitive, which means that the 20% will ultimately find their way onto the utility also. That’s part of why central counterparties and central securities depositories exist too.
5) At least one panelist was deeply concerned about what happens when Quantitative Easing goes into reverse, fearing that liquidity will flood the market with a high threat of stagflation. That was not a major market sentiment but should certainty be noted as a possibility.
6) Central counterparties for the buy-side were seen as attractive and perhaps inevitable. There were questions about who might really enter the market besides Eurex, as little has been seen publicly from LCH.Clearnet, the Options Clearing Corp and CME Group in this regard. It still isn’t possible to publicly find DTCC’s filing to the US SEC for making GCF Repo (R) available to buy-side money market funds. Buy-side CCP trends are making headway though and are expected to increase in importance. Likewise, the more that CCPs can put into their liquidation sets, the more opportunities they will present to the market.
Our thanks to sponsors DTCC-Euroclear GlobalCollateral Ltd in London and Zurcher Kantonalbank in Zurich for helping make these events happen.