First, we would like to wish all our readers a happy, healthy and prosperous 2013. In this article we take a look at what questions 2013 brings to the world of securities finance including expanding eligible collateral, sell-side business models and regulatory updates.
The biggest dog on the block for 2013 is collateral management and OTC derivatives. Large banks have already poured substantial resources into figuring out how to optimize their securities, forcing changes to their business model along the way. Small and medium players, mostly asset managers, have played a wait and see game, but their time will run out this year. Will they be pushed into the eager hands of their custodians or prime brokers for solutions?(1) Will those investors pull back from the OTC derivative markets?(2)
What about expanding the world of eligible collateral?(3) CCPs will need to backstop less liquid collateral with facilities to convert that paper to cash. The appetite for providing those backstops must come from the banks (or central banks) and we think there will be limited capacity to go around. Given our expectation for only a modest expansion of acceptable collateral, investors who need to post acceptable collateral to their CCP clearing members will either need to own or borrow more eligible paper. We have written in our December, 2012 paper “Sizing up the Collateral Transformation Trade” that there is plenty of collateral to go around, just that market friction will make efficient allocation challenging. The more collateral types that CCPs will accept, the less need for additional purchases or borrows by end-users, but that story is likely to extend well beyond this year.
The many different groups of constituents impacted by regulatory reform all have one thing in common – the preference for the rules to take effect later than sooner. We have already seen delays in Basel III announced. It is not hard to imagine more delays.
How will the sell side fare in 2013?(4) The UBS amputation of fixed income, one could argue, is not a trend but more of a special case. But the door is now open to sell side firms to simply exit business lines, as noted in a SunGard/PRMA report from last October. The cost of capital necessary to support financing and trading businesses is hard to calculate, but we do know it is going up. Will markets be elastic enough to allow passing the extra costs through?(5) If not, does the reduced profitability still justify the investment?(6) Will the market have to shrink first before spreads widen and new players emerge?(7) Banking regulators have been quoted as saying, more or less, that they wanted banking to “become boring again.” OTC derivatives are not a boring business and will suffer as a result. Market liquidity and risk management will also be hurt; unintended consequences of attempts of make the entire world “box standard.” Listed derivatives markets could be the winner, including the futurization of the OTC markets.
Will 2013 be the year that the regulators throw in the towel on bilateral repo and securities lending and push markets toward a broad centrally cleared world?(8) Will we end up closer to eliminating unwind/rewind risk in tri-party repo by the end of the year or will the Fed toss out the model altogether?(9) When will trade repositories become a reality and how will the data be crunched?(10)
2013 promises to be an interesting year. Hopefully not in a Chinese curse “interesting” kind of way, but a year that solidifies the progress that markets have made and forges ahead in a productive and sustainable fashion.