The elephant(s) in the room
19 February 2016
CCPs, indemnification, regulation, a collateral shortage and more dominated discussion at the Clearstream GSF Summit in Luxembourg
Image: Shutterstock
The 20th Clearstream GSF Summit in Luxembourg opened with a 鈥榤ilestones and memories鈥� session that saw nine industry professionals discussing the highs and lows of their careers.
For good or for ill, the panel explained, the spotlight that was shone on various aspects of this niche financial sector in the immediate aftermath of the crash helped stimulate education in the wider financial sector and ultimately boosted business for long-neglected securities lending and repo desks.
鈥淚 remember when I got a call from the CEO one day shortly after the crisis who was very surprised to hear that we had a repo desk at the bank. He was very interested to learn what exactly it was we were doing,鈥� reminisced one panellist.
The industry has come a long way since 2008 and the whole panel was overtly bullish about its future.
Although, according to the panel, there are many issues still to be addressed in the coming months and years that will have the potential to cause huge disruption throughout the industry, if they are not handled properly.
These include, but are by no means limited to: the suitability of the central counterparty (CCP) model to securities lending; the unintended consequences of the Financial Transaction Tax, Basel III and European Market Infrastructure Regulation on the likes of the repo market; a potential collateral shortage; and the future of indemnification.
Keynote speaker Andy Jobst of the International Monetary Fund tackled CCPs, stating: 鈥淎ll the evidence shows that collateral fluidity across CCPs is essential for their use to be maximised.鈥�
Jobst argued that CCPs, as a concept, are good for the industry and will likely become an established feature sooner or later, but the lack of balance sheet netting benefits is holding back their progress.
Moving onto the struggles of the European repo market, Jobst claimed that it is simply becoming 鈥渦nprofitable and uneconomic鈥�.
But not everything was negative. 鈥淲ithout quantitative easing we would be in a much worse place in the repo market,鈥� he added.
Overzealous regulation, specifically Basel III鈥檚 liquidity coverage ratio (currently only 70 percent implemented), was highlighted as a major driver behind the European repo market becoming less attractive.
鈥淲e need better regulation that understands (and tackles) market risk but also understands the collateral damage that a regulation may cause,鈥� explained Jobst.
This point was reiterated later by BNP Paribas鈥檚 Eugene McGrory, who said: 鈥淭he liquidity ratio is the biggest single challenge to the repo market in recent years.鈥�
The gravity of the situation
Regulatory demand for collateralised trading is dragging more and more organisations into the orbit of collateral optermisation, giving more weight to automated margin calling services as a result.
鈥淎utomation will help the buy side to manage the growing demand for daily margining,鈥� explained Chris Walsh of AcadiaSoft. Rob Scott of Commerzbank concurred and raised the point that outsourcing margin functions is a valid option for buy-side firms feeling swamped by daily margining requirements.
The question of concentration rules for initial margins was raised in a question and answer session. Both panellists and audience members were critical of the ambiguous rules currently being set both in and outside of Europe. One panellist pointed out that although initial margins were set for some regions, there was a distinct possibility they could change before the final draft is confirmed.
For once, regulation was seen as a boon by Clearstream representatives, who outlined how they are 鈥渦niquely placed鈥� to take on the business created by new requirements to centrally clear and collateralise trades. The overhaul of Deutsche B枚rse鈥檚 securities lending services and Clearstream鈥檚 Global Liquidity Hub were highlighted as central to the post-trade provider鈥檚 plans to leverage the upcoming opportunities.
According to Clearstream, the concern over demand for high-quality liquid assets becoming unsustainable is a non-issue.
Demands for collateral will reach roughly $4 trillion in the next few years, attendees heard, but representatives of Clearstream were unconcerned. 鈥淚t鈥檚 not that there [won鈥檛 be] enough collateral,鈥� explained one senior Clearstream representative. 鈥淚t鈥檚 just that there is a problem with the mobility of collateral that should be available in the market.鈥�
鈥淏eneficial owners with long positions on government bonds may not be tempted to enter the lending space now when there is only 5 or 6 basis points (bps) to be made, but if that goes up to 20 or 25 bps, I think we will begin to see more securities being released for lending. It鈥檚 already starting to happen.鈥�
The gulf between supply and demand in the securities lending space is, according to Clearstream, a strong indicator that there is no reason to worry about a collateral shortage any time soon.
For good or for ill, the panel explained, the spotlight that was shone on various aspects of this niche financial sector in the immediate aftermath of the crash helped stimulate education in the wider financial sector and ultimately boosted business for long-neglected securities lending and repo desks.
鈥淚 remember when I got a call from the CEO one day shortly after the crisis who was very surprised to hear that we had a repo desk at the bank. He was very interested to learn what exactly it was we were doing,鈥� reminisced one panellist.
The industry has come a long way since 2008 and the whole panel was overtly bullish about its future.
Although, according to the panel, there are many issues still to be addressed in the coming months and years that will have the potential to cause huge disruption throughout the industry, if they are not handled properly.
These include, but are by no means limited to: the suitability of the central counterparty (CCP) model to securities lending; the unintended consequences of the Financial Transaction Tax, Basel III and European Market Infrastructure Regulation on the likes of the repo market; a potential collateral shortage; and the future of indemnification.
Keynote speaker Andy Jobst of the International Monetary Fund tackled CCPs, stating: 鈥淎ll the evidence shows that collateral fluidity across CCPs is essential for their use to be maximised.鈥�
Jobst argued that CCPs, as a concept, are good for the industry and will likely become an established feature sooner or later, but the lack of balance sheet netting benefits is holding back their progress.
Moving onto the struggles of the European repo market, Jobst claimed that it is simply becoming 鈥渦nprofitable and uneconomic鈥�.
But not everything was negative. 鈥淲ithout quantitative easing we would be in a much worse place in the repo market,鈥� he added.
Overzealous regulation, specifically Basel III鈥檚 liquidity coverage ratio (currently only 70 percent implemented), was highlighted as a major driver behind the European repo market becoming less attractive.
鈥淲e need better regulation that understands (and tackles) market risk but also understands the collateral damage that a regulation may cause,鈥� explained Jobst.
This point was reiterated later by BNP Paribas鈥檚 Eugene McGrory, who said: 鈥淭he liquidity ratio is the biggest single challenge to the repo market in recent years.鈥�
The gravity of the situation
Regulatory demand for collateralised trading is dragging more and more organisations into the orbit of collateral optermisation, giving more weight to automated margin calling services as a result.
鈥淎utomation will help the buy side to manage the growing demand for daily margining,鈥� explained Chris Walsh of AcadiaSoft. Rob Scott of Commerzbank concurred and raised the point that outsourcing margin functions is a valid option for buy-side firms feeling swamped by daily margining requirements.
The question of concentration rules for initial margins was raised in a question and answer session. Both panellists and audience members were critical of the ambiguous rules currently being set both in and outside of Europe. One panellist pointed out that although initial margins were set for some regions, there was a distinct possibility they could change before the final draft is confirmed.
For once, regulation was seen as a boon by Clearstream representatives, who outlined how they are 鈥渦niquely placed鈥� to take on the business created by new requirements to centrally clear and collateralise trades. The overhaul of Deutsche B枚rse鈥檚 securities lending services and Clearstream鈥檚 Global Liquidity Hub were highlighted as central to the post-trade provider鈥檚 plans to leverage the upcoming opportunities.
According to Clearstream, the concern over demand for high-quality liquid assets becoming unsustainable is a non-issue.
Demands for collateral will reach roughly $4 trillion in the next few years, attendees heard, but representatives of Clearstream were unconcerned. 鈥淚t鈥檚 not that there [won鈥檛 be] enough collateral,鈥� explained one senior Clearstream representative. 鈥淚t鈥檚 just that there is a problem with the mobility of collateral that should be available in the market.鈥�
鈥淏eneficial owners with long positions on government bonds may not be tempted to enter the lending space now when there is only 5 or 6 basis points (bps) to be made, but if that goes up to 20 or 25 bps, I think we will begin to see more securities being released for lending. It鈥檚 already starting to happen.鈥�
The gulf between supply and demand in the securities lending space is, according to Clearstream, a strong indicator that there is no reason to worry about a collateral shortage any time soon.
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