A roundup of recent news that we otherwise haven’t gotten to yet.
1) Collateral Shortages. The ` ran an article that basically said that collateral shortages didn’t exist, but recognized the large imbalances that a race for collateral would have in financial markets. We said much the same thing in our December 2012 report on collateral transformations. The BIS article covers other old ground, for example an expectation of a structural demand increase in collateral of US$4 trillion (smack in the middle of our range), and that collateral demands will drive up the cost of High Quality Assets. The new addition is a conversation on the impact of procyclicality – what happens when all market players need a lot of new collateral at once? A big and expensive mess, that’s what happens.
The procyclicality concern brings us back to the ISDA analysis of non-cleared collateral shortages from November 2012. In a briefing, ISDA was citing procyclical collateral demand reaching up to 3X the amount of regular demand: “There is a real possibility some banks might fail to raise sufficient funds. In 2008 raising single-
digit billions of USD was very challenging. Raising multiple tens of billions of USD might not be possible.” We concur.
2) Indemnification, Fee Splits and Competition. Financial News offered up a story on Sept 16 that included some talk about indemnification and fee splits: “Agent lenders can price in the indemnification, absorb the cost themselves or offer a product without indemnification. The first two will translate into higher prices and this has led to discussions over fee splits, where custodians share income from securities lending with the beneficial owners. However, the industry has not yet come out in favour of any of these options.” While of course the market remains in flux, we have one additional comment that the article doesn’t mention: the potential for unpleasant price wars in the event that major custodians with one set of regulations must charge for indemnification, while other custodians operating under different rules (non-SIFIs, trust banks, different jurisdictions, brokers with principal programs) can offer all the indemnification they like but not have to take as much of a capital charge for it. We think that this pricing competition as much as anything else could make the biggest changes in securities lending over the next three to five years.
3) Hedge funds and collateral management in Asia. Ted Leveroni of OMGEO published an advertisement/op-ed piece in The Asset magazine that bears highlights for its prescient comments on how Asia will change the collateral landscape. We are looking ourselves at Asia as a big new frontier for securities finance, and will be running some trainings there in early November. Some important points from Ted’s article:
– Citing BNY Mellon, 80 cents of every dollar managed by Asian hedge funds comes from US investors, making Asian hedge funds tightly coupled to US regulations.
– “Hedge funds also face a greater need for collateral transformation and collateral optimization strategies to make the most efficient use of their capital and to compete effectively.” Hmm.
– Tech is the competitive advantage. We agree.