THE GLOBAL CHALLENGE.
The new regulatory focus on risk management has put the spotlight firmly on collateral supply and mobilisation. Stefan Lepp* discusses with Best Execution a new approach in the post-crisis world.
There has been much debate on the size of the potential shortfall in collateral in the market. What is your view on this?
As we know, more trades must be collateralised under new regulations. Estimates of the necessary collateral supply in the future range from many trillions to none, and this already tells you a great deal about the uncertainty and confusion in the market. But the question is not if there is enough collateral – and I believe to a certain degree that there is – but whether institutions can identify, access and mobilise it quickly and smoothly across multiple time-zones.
Many institutions do have a single view of their fragmented collateral across multiple locations and time-zones and such institutions might also have a picture of worldwide exposures to be covered on a daily basis (more or less in real-time). But what they are often missing is a facility enabling global collateral consolidation as a basis for optimised collateral allocation across all available collateral positions towards multiple exposure locations. Suppliers can achieve this through creating strategic partnerships with institutions holding collateral (central securities depositories, agent banks, global custodians, etc.) while building links to globally active exposure locations (such as CCPs). This model enables previously inaccessible collateral to be mobilised and so softens the impact of the collateral crunch significantly.
How sophisticated does collateral management need to be?
That depends on the institution and their activities but most need collateral management on a real-time and cross-market basis. Without this, institutions cannot deliver the best – i.e., the cheapest, eligible – collateral to each exposure point. For example, they might have to use triple-A rated paper to cover an exposure only requiring single A+ because the single A+ is in another location and cannot be mobilised on time. Systematically over-collateralising in this way bears very high opportunity costs; a Clearstream-Accenture study conservatively reported that this cost globally is north of EUR 4 billion.
How is the industry tackling this challenge?
A dedicated collateral management system used to be seen as optional and not a key product. Since the financial crisis, however, collateral has become a worldwide issue and any market solution must meet this global scale. My company, for example, is currently in strategic talks with many institutions, such as CSDs, wanting to become local collateral service providers. CSDs have a central role in national economies and are often well-positioned to deliver secure services to their local markets. These days, however, they run a commercial risk if they cannot meet their client’s collateral management needs.
A Finadium study in May 2012 found that only 13% of CSDs surveyed could deliver collateral optimisation, but trying to develop the necessary technology in-house can be a lengthy and costly business. A sustainable solution is for infrastructures to insource a sophisticated system quickly and cost-effectively. This approach has been adopted by the Liquidity Alliance, an association of five CSDs (currently) from around the world which share the same approach to collateral management and believe that strategic partnerships are the smart way to beat the global collateral challenge.*Stefan Lepp is a member of the Executive Board of Clearstream and head of its Global Securities Financing division. ©BestExecution 2013