By Anthony van Eden – Head: Collateral Management Services, Strate
The Collateral Management team at Strate attended Clearstream’s Global Securities Financing Conference in Luxembourg in January 2016.
The Group of 20 (G20) regulatory reforms to ensure stable financial markets continues to gain traction in the Eurozone, which already has several licensed trade repositories in operation. The European Securities and Markets Authority has issued regulation governing the clearing and margining of Over the Counter (OTC) derivative transactions effective from 1 September 2016.
While most market players are aware that ‘all standardised OTC derivative contracts should be traded on exchanges or electronic trading platforms, reported to trade repositories and where appropriate, cleared through central counterparties’[1] , many may not anticipate the wider regulatory impact for uncleared OTC derivatives related to initial margin (IM) and variation margin (VM). The more noteworthy impacts being:
- IM requirements and daily VM imposed;
- Daily collection of two way IM on a gross basis;
- Collateral segregation for IM at custodial level and/or triparty agent
- Restrictions on reuse of IM collateral
The effects of these OTC reforms, while tightening security and supervision on an otherwise moderately regulated market, could mean that the Eurozone will require an additional several hundred billion Euros in collateral [2].
The 5 year OTC derivative regulatory roll out highlights potential outcomes such as:
- 85% of IM is to be posted must be High-Quality-Liquid-Assets (HQLA) such as sovereign fixed income.
- IM received in cash must be invested into money market funds due to the fungibility of cash;
- Collateral to cover IM will be called for in shorter cycles, and with fewer pools to source collateral, therefore the velocity of collateral will increase.
- The securities posted as IM cannot be reused causing a liquidity trap; therefore the cost of HQLA will increase. This will cause collateral givers to look to other eligible securities or use agents to transform available assets into eligible assets in order to meet their requirements.
- The connectivity with Repo desks and CCPs will have to improve as time lines become shorter.
- The regulatory changes will have significant operational impacts, especially impacting transactions where cross border time zones are involved.
So how do these developments in the Eurozone impact the South African financial market? A significant portion of South African OTC derivative transactions are with foreign counterparties, of which a large constituency includes the Eurozone. From March 2017 trading in OTC derivatives will have to conform to the margining rules of the local jurisdiction or Central Counterparty (CCP).
Furthermore, if recent regulatory changes in South Africa seem to have been coincidentally closely aligned to the Eurozone, and with South Africa being a member of G20, then it stands to reason that Eurozone reforms in the OTC derivative space could be just around the corner for the South African local traders. The cumulative effect of the IM and VM requirements will negatively impact the pricing of derivatives and place even greater pressure on the pools of available HQLA both locally and those held abroad.
If this is to be the new normal in the OTC derivatives market, then what should the strategy be to remain not only competitive, but afloat in this industry?
It is imperative to ensure that you have the ability to mobilise the required collateral for IM to the right place and in required timeframe from centralised pools of HQLA. The location and type of collateral as well as the cost of placing the collateral and, if you are a bank, the impact on the balance sheet ratios, need to be carefully simultaneously considered. Collateral fragmentation will prove costly. The time is right to ensure that pools of collateral can be accessed timely and automatically selected on a cheapest to deliver basis and substituted seamlessly be the available HQLA be on or off-shore.
It is has been estimated that once regulatory controls have been implemented globally, an estimated 99% of IM will be controlled by TriParty systems [3].
Strate’s collateral management service provides fully automated, integrated, near-time settlement of collateral placed through either pledge or cession. Securities placed as collateral remain within Strate. Furthermore, securities ceded are protected from disposal by the collateral receiver as only the collateral giver can dispose of its securities once other eligible assets have been substituted with the collateral receiver. A detailed audit trail of permitted reuse of collateral assets ceded is retained and the return of ceded assets follows the initial reuse chain.
[1] European Market Infrastructure Regulation (EMIR)”. European Securities and Markets Authority. Retrieved 22 January 2016.
[2] Apers. B. (2016, January 16). Initial Margin for OTC Derivatives. Speech presented at Clearstream Securities Financing Conference in Luxembourg, Europe.
[3] Apers. B. (2016, January 16). Initial Margin for OTC Derivatives. Speech presented at Clearstream Securities Financing Conference in Luxembourg, Europe.
Contact Collateral Management:
Anthony van Eden
Head: Collateral Management
+27 (11) 759 5314
