The vast majority of large banks and broker-dealers believe quality of collateral should be given equal consideration to cost when choosing to connect to post-trade securities market structures, according to a recent study by SIX Securities Services.
In total, 92% of respondents believed quality and cost of collateral should be on par and 85% thought selecting a market infrastructure on cost alone increased exposure to risk.
The study, which focused on both equities and derivatives trading, found the largest sell-side banks thought there was enough collateral in the system, but due to regulatory requirements, the liquidity was not being distributed efficiently.
Increased interoperability in the cash equities market driven by new regulation and the forced clearing of over-the-counter (OTC) derivatives trades through central counterparties (CCP) will force firms to post more collateral for trades, significantly altering their collateral management practices.
Although 69% of respondents believed there was enough collateral to go around, the 31% who did not, estimated the shortfall ranged between 5 and 200%.
The micro-survey, designed to take the pulse of industry leaders on collateral management issues, was conducted by post-trade services provider SIX Securities Services at the Sibos banking conference in Osaka, Japan this week, with the majority of the 13 respondents representing tier one banks.
Thomas Zeeb, chief executive officer of SIX Security Services, believes collateral management and its optimisation are major concerns for financial institutions, and said collateral was not being distributed efficiently.
“Some central counterparties believe that generating new collateral by securitising and repackaging existing portfolios is a way forward. I fundamentally disagree with this approach. That the industry is already thinking about repeating the sins of the past, by repackaging securities to create new collateral pools is frightening,” Zeeb said, adding finding providers of large-scale quality collateral was a clear concern of the industry.
“Collateral should be simple, of high quality, liquid, and easily-valued. Competing on poor collateral quality sows the seeds for the next failure and subsequent crisis,” Zeeb said.
A whitepaper on collateral management published this week by 4Sight Financial Software has also found two major trends emerging in the collateral space.
Firms are using increasingly sophisticated methods to monitor and control counterparty risk, with greater consideration given to liquidating collateral in the event a CCP defaults, the paper states.
Also, greater cost reduction mechanisms are being employed in an effort to optimise collateral due to the apparent squeeze on high quality collateral.
The whitepaper believes the increasing regulatory strain on buy-side firms ahead of the central clearing of OTC derivatives in the US, under Dodd-Frank legislation, and Europe, under EMIR regulation, has pushed costs up, as firms must pledge more cash and highly rated sovereign bonds to meet margin requirements for derivatives trades.