Collateral demands become more timely and proscriptive

Contrary to popular opinion, the financial markets have enough collateral – some US$75 trillion – but the problem is access, availability and quality.

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Contrary to popular opinion, the financial markets have enough collateral – some US$75 trillion – but the problem is access, availability and quality.

Such a situation has led to the ascendency of the importance of collateral management as regulators move to make the financial system safer with rules such as the Dodd-Frank Act in the US and the European market infrastructure regulation.

In a session at Sibos in Osaka entitled ‘Collateral management insourcing – the next frontier’, panel chair Godfried De Vidts, director of European affairs, ICAP, discussed how firms should deal with the increasing collateral requirements and OTC derivatives.

The question for institutions, according to De Vidts, was how to access and manage good collateral when many sovereign bonds were being downgraded and a broader range of instruments required more proscriptive collateral.

“You need to be sure you use collateral wisely, in the right place and at the right time,” he said.

Smart partners

Given the predicted shortage, smart partners were needed all along the transaction chain; infrastructure, global custodians, agency banks, central counterparties.

The essential problem was that in different jurisdictions, more – and better quality – collateral was being demanded by regulators to cover a wider range of instruments; and it is being required faster.

“People are required to post collateral for disciplined margin calls throughout the day,” said Jo Van de Velde, managing director, Euroclear, providing an example of how quickly collateral was now often needed.

“You need to be able to deal with more segregation, discipline and reporting requirements. Collateral is like electricity – you need it everywhere. It is becoming systemic in nature,” he observed.

But Van de Velde warned that collateral management and risk management were two different things: “You can’t become over-reliant on collateral.”

Greater demands were also being placed on various forms of collateral, the panel explained.

“Strong Asian economies have meant increasing demand on local currencies,” Taketoshi Mori, head of security market infrastructure, Bank of Tokyo-Mitsubishi UFJ said of the present experience in Asia. “What is important in collateral is liquidity, financing and funding.”

And new instruments were also being collateralised.

“Bank loans are now being looked at as a form of collateral, and even if you had to put up perhaps a 70% haircut, that might be okay if the loans were valuable,” said Stefan Lepp, CEO of Clearstream Banking.

However, Alain Pochet, head of clearing, custody and corporate trust services at BNP Paribas, warned that while anything could theoretically be collateralised, not everything should.

“Of course you could collateralise a whole range of new instruments but you need to be concrete in your valuation and definition,” he said. “The issue would not just be the new forms of collateral which would need to be dealt with, but also that everyone agreed on them.”