A new service from the French arm of central securities depository (CSD) Euroclear will help the buy-side post collateral to support OTC derivatives trading, but a leading bank has stressed that sell-side expertise should not be ignored.
Nomura has warned that the downgrading of sovereign debt poses challenges to the risk management capabilities of central counterparties as they become familiar with handling a wider range of instruments.
“The skill set required to manage those risks isn’t typically found in the treasury functions of a CCP,” said Michelle Neal, global head of fixed income electronic markets, futures and options and OTC derivative clearing at Nomura.
Euroclear France is the latest to develop its buy-side offering, by acting as a central provider for the management of collateral against cleared transactions.
The CSD has announced plans to extend a tri-party repo collateral management service it launched last year. The service will automate the processing of collateral transfers associated with interbank repos and other securities financing transactions using securities held in the French CSD as collateral.
The broader service will be launched in June and is being developed with Anglo-French clearing house LCH.Clearnet, acquired last week by the London Stock Exchange, which will provide the clearing, netting and guarantee services and use Euroclear France to identify and allocate the necessary collateral.
The scheme, which was initially developed in conjunction with Banque de France, allowing the central bank to collateralise exposures arising from domestic credit operations, will now include the rest of the French banking community.
The CSD said it also planned to extend the service to the Euroclear Settlement of Euronext-zone Securities Community, which will let repo transactions across Belgium, the Netherlands and France be supported by the same collateral management system and procedures.
Running dry?
While collateral solutions continue to emerge, Nomura has warned that issues related to how much high-quality, liquid collateral is available for clearing have been largely overlooked and could create funding issues for institutions looking to meet collateral requirements. A recent paper from research Finadium also looks at whether corporate bonds with less than a AA rating and some equities will be able to fulfil collateral needs.
“There is recognition that banks provide collateral services and funding solutions to clients as part of an overall relationship,” said Neal.”[Banks] are probably best suited to facilitate the transformation of ineligible collateral into eligible collateral.”
A report from investment banking consultancy Rule Financial which reviewed bank and dealer preparation for the Dodd-Frank Act, noted 90% of sell-side firms either already offer collateral transformation services or plan to develop them within the next 12 months. The burgeoning collateral swaps market, where buy-side firms lend gilts and other high-quality assets to banks in exchange for a lending fee and other types of corporate bonds, is also emerging as a channel for buy- and sell-side firms to manage their new collateral obligations.
A number of sovereign downgrades over the last year have meant many associated fixed income products will no longer be suitable as the high-grade collateral required to meet clearing obligations under the new OTC derivatives rules.
According to Neal, if such factors cause clearing houses to move down the credit spectrum, in terms of the collateral they are willing to accept, “it fundamentally makes for a more risky environment”.