Collateral crunch looms for asset owners
In a low-growth, low-interest rate world, how you maximise the returns from your current holdings will be a key determinant of future success.
Moreover, with regulators and exchanges forcing most, if not all, forms of financial transaction onto exchanges, the demand for collateral will reach new highs.
As Asian asset owners are holders of the largest pools of highly rated securities in the world, they will play a crucial role in the fast developing world of collateral management.
For many in the market, this is a critical issue – not in the future, but now.
According to Michael Cole-Fontayn, chairman of Emea of BNY Mellon in London, there are not enough sources of high-quality capital to meet the collateral needs that are projected in the next 18-24 months.
“The challenge is that there is not enough collateral in the world to supply all the new regulations that are being proposed,” he says.
A typical example of a collateral trade might be that an exchange is demanding an asset manager post a percentage of the value of a trade as collateral for clearing it. However, the manager does not want to have to sell positions to post cash, and does not have a raft of highly rated bonds sitting around.
Therefore they can enter in a repo or securities-lending transaction with a bank. The bank, in turn, sources the requisite securities from a large asset owner such as a central bank that is sitting on billions of US Treasuries. This is on-lent to the asset manager, who posts it as collateral.
Such a trade makes sense for the manager as it lowers the transaction costs; it makes sense for the asset owner is it can optimise their returns; and clearly it makes sense for the bank and exchange as they take a fee for making the trade happen.
“With the increased use of exchanges, the optimising and management of collateral will be critical,” says Cole-Fontayn. “And the institutions that get it right will have to get it right across regulatory and geographic boundaries.”
Cole-Fontayn notes that that bank just hosted its third annual sovereign wealth fund Academy, attended by SWFs from Asia and around the world, and for the first time collateral management was at the centre of discussions.
“They now see it [collateral management] as a source of capital management and prudent reserve management and selectively a return opportunity,” he says.
It is potentially an exciting new source of revenue for banks, and as such its power to improve their business should be taken with a degree of scepticism. But unless the regulators start to ease back on their rules (which seems highly unlikely), this trend does look valid.