The Bank of England released their quarterly bulletin yesterday with some interesting survey comments on collateral management and collateral transformation. These were consistent with the FSA’s February 2012 release, “FG12/06, Collateral upgrade transactions (includes liquidity swaps).” We present the highlights below.
“Contacts reported that financial market participants were managing the increased need for collateral in a number of ways. These include (i) managing collateral more efficiently; (ii) using so-called ‘collateral transformation services’; and (iii) loosening collateral criteria.”
(i) Collateral management
“Contacts noted that their focus on collateral had increased markedly since the financial crisis: what had previously been an administrative function had become an important part of trading decisions and pricing.”
Highlights of this section:
– Much greater emphasis at banks on centralization and risk management of collateral resulting in cost efficiencies.
– Collateral analyses and cost management showing the true cost of capital of different business units.
– Better understanding of counterparty risk.
– Pricing now more in line with Credit Support Annexes.
– Tri-party agents gaining in popularity, and costs were outweighed by operational efficiencies.
(ii) Collateral transformation
“”In contrast to widespread media commentary, contacts voiced few concerns that the increased need for collateral would lead to an overall shortage. But some were concerned about how collateral was distributed. In particular, CCP clearing of OTC derivative trades and posting of bilateral margin would affect certain market participants, such as insurance companies and pension funds, that were not used to providing collateral. The challenge for those entities would be to source and mobilise the eligible securities in a timely manner and at a reasonable cost.”
– Clients report interest in collateral transformation services.
– Terms that banks are offering vary considerably.
– Maturity and credit mismatch an issue.
(iii) Loosening of collateral criteria
“One effect of the increase in demand for collateral has been a partial reversal of the post-crisis tightening of collateral criteria in some lending markets, both in the United States and Europe. For example, lenders who previously only accepted government bonds as collateral were reportedly starting to accept cash and equities. And in OTC derivative markets, some CCPs and other risk-averse counterparties were also slowly extending the range of assets eligible as collateral (against greater haircuts), with a number of market participants predicting that CCPs would become more flexible in their collateral requirements. A loosening of collateral criteria has the potential to ease pressure on higher-quality assets and was considered a helpful development by contacts, provided that adequate risk controls (including haircuts) were in place. Some contacts, however, expressed concerns that, over time, competition might lead to an excessive loosening in CCPs’ collateral eligibility criteria.”