Fund managers doubt collateral transformation services

In order to raise cash fund managers will have to rely more on their clearing brokers to meet initial margin requirements.

Fund managers are growing increasingly suspicious of the cost of “collateral transformation” services provided by banks, according to a new white paper from the DTCC.

In order to meet new margin requirements, fund managers are required to hold more cash to guarantee their OTC derivatives trades. However, they are not natural holders of cash, and are therefore being encouraged to use the triparty repo or new collateral transformation services in order to raise cash.

This means they have to rely more on their clearing brokers in order to comply. But as the buy-side become more cost conscious with regards to clearing, more fund managers are becoming wary of the charges applied to these collateral transformation services.

“Collateral transformation’ is a fantastic euphemism,” says one fund manager in the white paper. “It means, `We will take whatever you have got, and charge you an awful lot to convert it into something that is useful,’ almost to the point that you are thinking, `What is the point in trying to do it?’ You are giving up most of the credit spread.”

Another fund manager also said that banks are re-pricing their collateral transformation services as a result of capital constraints reducing the profitability of clearing.

A study by the European Commission in 2014 estimated it would cost European pension funds between €2.3-4.7 billion a year to maintain sufficient cash buffers to meet variation margin calls. It also said collateral transformation by agency lenders and clearers would not be able to meet the full needs of the European pension fund community.

However, a survey of 89 fund managers conducted by the DTCC in October last year found that nearly nine out of ten managers are ready to obtain cash collateral.