FTSE Global Markets magazine released a good article recently on collateral optimization. We pull out the highlights and offer some observations.
The article is “Collateral optimisation: Managing the cost, mobilisation and velocity of collateral,” an interview with six market participants. Of note:
Karl Wyborn, JPM: “increasing the velocity of collateral and improving optimisation are the two themes that we have prioritised.” The velocity of collateral has been much discussed in Securities Finance Monitor and elsewhere. As CCPs drop collateral velocity to 1, JPM wants to increase it. The JPM objective makes sense and aligns well with market needs. We wonder if increasing velocity internal to a custodian might conflict with regulatory objectives in reducing rehypothecation or whether that is viewed as lower risk. It could be an interesting strategic play.
Ben Thomas, Deutsche Bank: “The effort for us in the last, certainly twelve to 18 months, has been in trying to expand the scope of what we do across product and bringing together a bunch of desks across the investment bank that have similar optimisation roles into an integrated solution.” We see the trend towards consolidating collateral management desks increasing. We noted a similar theme in the recent Murex/InteDelta survey on banks and CVA desks.
Peter Left, Lloyd’s Bank: “it is about trying to bring all these people in the puzzle together.” That’s another theme – creating a central market.
Saheed Awan, Euroclear: “To exchange corporate paper or index-linked equities for high quality government securities you are looking at 50bps to 75bps, plus an indemnity to nullify the risk. That’s the issue. What is the level of comfort that these big holders are going to need to unload some of the supply to help the shortage?” What a great question! We’ve spent a lot of time asking beneficial owners what the right clearing price is for these assets. The answers are a big range, but can go as high as 100 bps in the current environment. Repo data for alternative collateral show this figure to be well out of reach currently. Going forward, this is going to be a key question. As a side point, Global Investor/ISF reported that at the recent Clearstream/GSF conference, 50% of attendees expected a collateral shortfall at some point in the future. That puts some teeth into Mr. Awan’s questioning.
Karl Wyborn, JPM: “There is now a far greater correlation between risk and cost for the buy side than there was ever before.” We would add that there is a much greater propensity for banks to want to transfer risk to their buy-side clients and CCPs, and act more as agent, not principal. This changes the cost equation. JPM again is taking an interesting route: “As a collateral agent for both the buy side and the sell side, our objective is to break the direct correlation between risk and cost.”
Martin Seagroatt, 4Sight: “In the longer term, maybe an exchange for collateral trading will evolve. Perhaps we could even see collateral turning into a derivative in its own right.” We’ve actually heard about this being attempted already. Its an interesting idea, maybe a little too early to come to fruition, but we agree with Martin that this is a possibility.