The collateral industry might have hoped for a period of calm after a decade of tumultuous change. But as delegates to the 17th annual Euroclear Collateral Conference heard, it remains as dynamic as ever. The drivers of change are all around, but four key themes emerged from the two day event, attended by over 600 delegates.
Future market conditions and their impact on bank capital, was a key underlying topic of discussion. The impact of new regulations in 2019 and 2020 was a cause for concern. The risks that were creeping into the system were noted, particularly by those with the widest viewpoints. And the potential of new technology and platforms to radically alter the industry were also discussed widely.
The conference panels highlighted the many solutions Euroclear has in place or is developing in collaboration with the market. Having access to the biggest network, with the broadest liquidity, the latest technology and the lowest risks always makes sense.
Bank Capital Efficiency
Speakers from some of the world’s largest banking institutions confirmed that, contrary to what has been seen before, banks now have far greater balance sheet capacity.
They also stressed that this may be due to artificial liquidity levels being by recent regulatory intervention and that capital efficiency remains a concern.
Meanwhile the cost of capital, while currently low, is nevertheless increasing, and expected to get even more expensive.
At the same time, banks are judged by their shareholders and their senior management by how efficiently they can make returns on their large pools of retained capital.
This means that there is great pressure on the industry as a whole to use collateral wisely and to make all ancillary business lines, such as custody, securities lending and settlement services, as efficient and as automated as possible.
The successive waves of regulations that have washed over the industry show no signs of abating.
The enormous operational effort that will be needed to comply with Securities Financing Transactions Regulation (SFTR) in Q2 2020 on the securities financing side of the business was cited by many speakers.
Phases 4 and 5 of the Uncleared Margin Rules (UMR) are due to come into force in 2019 and 2020.
They will have a huge impact on a vast number of asset managers – an impact that might not yet be fully understood by those firms.
The implementation of CSDR is also a cause for concern, with features such as fines and mandatory buy-ins, being cited by many delegates as a potential headache.
Harmonisation of the processes and standards used across European markets remains the ultimate goal for collateral management practitioners.
But the truth is that the market needs short-term solutions to improve collateral mobility, right now, well before it starts moving towards a more distant collateral union.
Many of the solutions that do exist are struggling to gain traction.
A prime example is T2S, which offers tremendous opportunities to standardise and boost efficiency but is barely understood by the market - many firms are only now starting to take more detailed look at potential benefits.
If harmonisation is the ultimate goal, then the market will need to learn how to adopt new developments in a faster way.
As one speaker noted, one of the hurdles that is currently preventing greater take up and implementation of initiatives is the lack of alignment between various legislative texts, resulting in friction and ambiguity.
The day before the conference, the UK and the EU announced that they had signed a draft agreement on Brexit. The two days of the conference coincided with the UK administration trying to get internal support for this deal.
Delegates were constantly checking news sites for the latest updates throughout the event. It encapsulated perfectly the political risks that the collateral industry faces.
As one speaker noted, if the UK does crash out of the EU without a deal, the amount of re-documentation required to keep everything moving could overwhelm the industry.
Reassuringly, Euroclear speakers were able to confirm that, like many of its clients, the financial market infrastructure has assumed a worst case scenario is prepared for the massive potential volumes.
Another risk that was noted by distinguished speakers from outside of the clearing and settlement industry was the concentration risk that is amassing as CCPs grow larger and larger.
The lack of a resolution process if one of these CCPs were to fail, was mentioned a number of times.
The greatest optimism came from the technology experts, be they the developers of new platforms, or senior figures within the securities industry. Many delegates discussed the power of technology to significantly solve the problems of bank capital efficiency, regulatory overload, market transparency and even market and liquidity risks.
New horizontal platforms offer peer-to-peer or wall-to-wall connectivity for the wider collateral and securities lending markets, which offer a strong alternative to the overall push to central clearing.
Vertical platforms that link dealers and agents offer great leaps in efficiency. And behind it all is the prospect of Distributed Ledger Technology (DLT).
As one delegate noted, if DLT lives up to its promise, it will totally reshape the industry obviating the need for reporting, decreasing the need to tie up expensive bank capital, and bringing a transparency to bear that will reduce market risks.
While this nirvana might still be years away, delegates to the conference remain as enthused about the here and now as ever.
Those on the sell side have never had a more important role within their own institutions.
Those on the buy side now realise that effective collateral management has gone from a nice to have to a must have attribute, if they are to remain in business.
And the new service providers are excited about the chance to help change the industry.
Collateral remains one of the most important issues in the global financial markets.