Treating Collateral Trading as a Business: Natixis’s Test Case

The collateral trading business is shifting to accommodate new client interests, regulations and balance sheet requirements. Technology remains both a major opportunity and business model threat. This article presents Natixis’s view of how collateral trading is changing and how banks must consider their collateral trading efforts in alignment with internal and industry initiatives. A guest post from Natixis.

The term “collateral trading” can mean many things to different firms. At Natixis, we call collateral trading the business of optimizing secured assets. Treasury may manage all unsecured activity, but collateral trading, also called central collateral funding by some firms, looks after all available collateral and collateral requirements. Ten years ago, the term did not really exist. Businesses that touched collateral were siloed, both organizationally and technologically. Repo, securities lending, derivatives, Delta One, ETFs and Total Return Swaps were largely independent of one another. This created balance sheet and capital inefficiencies, to say nothing of confusing clients.

In 2017, we created a Securities Optimization Unit within the Global Securities Financing group that includes securities lending, repo and derivatives formats for both equity and fixed income assets. We know that some firms completely separate certain business units, for example securities lending, and this obviously impacts the available assets in the collateral pool. As a result, this reduces a firm’s ability to transfer assets and find optimal pricing across the portfolio. We have found it more effective to integrate our collateral-related products, structures and wrappers. Sales and Traders have become very familiar with the regulatory aspects of transactions, this of course helps on the structuring of the products. Besides the internal benefits, clients can see the whole securities financing product universe in front of them and choose what works best for their needs.

The big picture of business model change

Regulation continues to lead both Natixis and industry thinking about the future of collateral trading. The degree of regulatory change remains intense, and has moved from the headlines like NSFR and SFTR to more nuanced changes like how CCPs net securities lending transactions and clear OTC derivatives, and regulation for swaps dealers globally. This regulation is the overriding trend of how we must look at and manage the collateral business today.

Besides regulations that impact banks, we are now trading with and competing against non-bank institutions that operate outside of our regulatory framework. This is not to call these firms unregulated – in many cases they are – but their regulations are different than what banks face, and this results in an uneven playing field. While these market players do not have the depth of balance sheet that large banks hold, they also operate with a much lighter cost base, allowing them to supply liquidity to the market and add value.

Banks are still central actors in the collateralized trading markets but there is a move towards disintermediation. Peer-to-peer trading could broaden out the market, pulling in private banks, corporates, and hedge funds, among others. Buy-side clearing of repo, securities lending and OTC derivatives would remove the traditional bank intermediary role. The question is whether end-clients are ready to do the work of managing credit and, if necessary, liquidation of collateral assets. Banks know this business well, including how difficult it can be. In a normal market, alternatives to banks may be attractive to end-clients, but in a stressed environment, may also turn out to be a cautionary tale. While we are not concerned about disintermediation at the moment, it is an important trend to watch as we move forward.

Information providers are offering a new level of transparency to banks and clients alike. Hedge funds can look at where they are borrowing securities from prime brokers versus where the dealer-to-dealer markets are trading. Insurance companies can see how their securities lending revenue would compare to inter-dealer levels. Some trades cannot be comparable, for example a highly risk averse securities lending program will earn less than a fund with flexible collateral requirements, but the data can still be a useful tool. These data sources are changing the way participants look at the market, much the way that US TRACE reporting changed the corporate fixed income market. The data firms themselves could also turn into something more later on, for example exchanges or proprietary trading platforms.

Products, balance sheet and trading opportunities

The underlying economics of most collateralized trades are similar, but managing similar risks together is also important and has not been the industry standard; now, this is the only solution that makes sense.

Balance sheet and capital benefits as well as risk management preferences will be drivers toward increased use of listed products in general, and centrally cleared products in particular. Products will continue to become more commoditized in order to fit into the central clearing paradigm. From a balance sheet perspective, there is no choice: both we and our clients will be priced out of the OTC market for many activities. The OTC market will exist primarily to assist clients who need bespoke collateral trading solutions; all other business will be more cost effective and standardized enough to centrally clear.

Most of the securities financing business remains OTC, but this is changing. Currently, 75% to 80% of our business is OTC, but we would not be surprised if three years from now only 30% to 35% of the business remains outside of a CCP. The high cost of OTC trading and processing is a weight on the business, not to mention regulatory constraints, and management is constantly pushing toward more efficient alternatives.

A shift towards centrally cleared products implies major changes to the collateralized trading market. The market is in the closing days of the relationship model that made it successful to begin with. While people will always be needed, on-exchange and centrally cleared products mean that any firm with a clearing account can trade. From cleared securities loans, to buy-side participation in repo, to Total Return Futures and cleared Contracts for Differences (CFDs), this commoditization of both product and access removes the edge that banks have formerly enjoyed. Firms that do not account for the new market structure are in for a rough landing as profitability and risk models can change quickly.

The critical technology overlay

Technology across the entire bank is increasingly a central driver of competitive advantage, and collateral trading is no exception. Technology that enables a global view of collateral allows traders to optimize fungible assets across products, time zones and currencies. Our cross-product view gives us insights into global financing costs, allowing trading desks to anticipate markets and position liquidity accordingly. Trading an individual asset versus a basket and managing transfer pricing across the firm are only possible with robust real-time data analysis. Matching our internal collateral needs before going to market not only saves on balance sheet, but also allows us to serve our clients more efficiently.

Big data is a term thrown around by many in finance. The collateral trading world is seeing big data up close and personal in the Securities Financing Transaction Regulation (SFTR). The need to collect, manage, report and support the 153 possible fields that regulators require is daunting. Data must come from multiple platforms, often not supported by current business lines or technology groups. The sheer volume of data and the tight deadlines has made banks re-think their process flows and forced technology upgrades. But the lesson in big data is that there is value; banks that can see opportunities in using this treasure trove of numbers will be rewarded if they manage to spot trends and patterns. Pricing using this information is also a topic internally.

Machine learning and natural language processing have come to collateral trading. Already we see competition from market participants who have invested heavily in this technology and are pointing their sights on collateral trading.

Blockchain and DLT is another area of interest to Natixis but we must be realistic about time and resources. Some areas of collateral trading can clearly benefit from the automation and security that a distributed ledger can bring. We remain highly engaged and continue to experiment with DLT, but are not under any illusions about the time, money, and management focus it will take to convert markets. One thing is sure, if we want to increase our wallet share we will have to be able to respond faster to the growing number of RFPs primarily coming from our clients or through our sales teams.

At Natixis, we see a dynamic collateral market that promises not to slow down anytime soon. The global financial crisis may have been the catalyst of new regulation, but we are now going beyond what regulators have mandated and are using technology to enhance and defend our market positioning. But the real proof of our success, and our integration of collateral trading across products, is that client needs are met efficiently, risk is effectively managed, and our ROA is improved.

Simon Sourigon
is the Global Head of the Securities Optimisation Unit within the GSF (Global Securities Financing) group. Simon is responsible for the Securities Lending, Collateral management and Single stock trading teams worldwide (US, Europe, Asia). Simon has spent more than 14 years in Equity Finance, including 13 years at Natixis. Simon has a Master’s in Finance from ESLSCA Business School.

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