Sizing Up the Collateral Transformation Trade

Finadium
December 2012

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Collateral transformations are a potentially important means for banks and OTC derivative end-users to access securities for bank balance sheets and posting collateral. This trade, where cash or government bonds are exchanged for a “lower” credit asset such as corporate bonds or equities, could lift securities lending and repo markets while providing a valuable service. However, the trade is not without its hurdles, namely the economics and number of willing and able participants.

In this report, Finadium breaks down the mechanics, asset availability and demand for collateral transformations on the borrower and lender side. Whether the trade is conducted as a repo or securities loan, the numbers reveal disproportionate supply and demand for each subsection of the market where collateral transformations might occur. The conclusions to this exercise provide important lessons on the size and impact of the collateral transformation trade for market participants and regulators going forward.

Collateral transformations affect a broad cross-section of financial markets. As such, this report should be read by financial market participants that give or take collateral and their banks, securities lending agents, repo counterparties and technology providers. Institutions and asset managers holding portfolios of government bonds and money market securities, as well as regulators, will benefit from understanding the impact of collateral transformations on their investments.

This report is 33 pages with 12 exhibits.

TABLE OF CONTENTS

■ Executive Summary

■ Why Get Excited About Collateral Transformations?
– Pros and Cons

■ How Collateral Transformations Work
– Everyone’s Talking About It But Who Can Do It?

■ Calculating Collateral Shortfalls
– CCPs
– Bank Risk Capital
– Collateral for Non-Cleared Derivatives

■ Accessing Available Assets Through Collateral Transformations
– US Government Securities
– Non-US Government Debt

■ Follow the Money
– Winners and Losers

■ About the Author

■ About Finadium