Sometimes the early material in a report is so boring that even us dedicated expositors can do nothing better than to splash into the middle. This is one of those times. But there is important stuff in the middle and end of the recent report by the Committee on Payments and Market Infrastructures, a working group under the umbrella of the Bank for International Settlements.
The CPMI has issued a report on collateral management services. Nothing much matters here until Section III, which details the range of approaches that have been taken of lately by service providers to get their customers better tools for the proper deployment of their securities.
Already in 2006 the same working group, then known as the Committee on Payment and Settlement Services, said that financial institutions would find it “costly to hold sufficient quantities of eligible collateral in every market in which they operate directly, and may face mismatches between the location of their liquidity needs and the collateral they hold.”
Costly indeed! So … what to do about it? Before you answer that, consider the supply side issue. In 2013, a report of the Committee on the Global Financial System found no evidence of permanent or widespread scarcity of collateral in global financial markets. The problems are those of temporary supply-demand imbalances: matching the collateral to the circumstances. Now we’ll cut to the chase: how deal with those imbalances?
A Single View of Holdings
A custodian can start by providing its customers with a single view of the holdings at that custodian. Going further, some custodians are now supporting an aggregated view of holdings that includes assets held away from the primary custodians. This is known as a custody-agnostic model.
The CFMI applauds this development, as some customers “may be conducting business in jurisdictions where their primary custodian does not provide collateral management services.”
There is a lot of variety as to the timing of updates to this aggregate view. One model, which CFMI applauds as the most sophisticated of those this committee has observed, involves “the sending of a supplicate SWIFT message to the primary custodian when a transaction takes place at a secondary custodian, allowing for a near real-time update of the aggregate view.”
Aggregating or Transforming Assets
Then there is the matter of the aggregation of assets. Many International Central Securities Depositaries are trying to arrange this for mutual clients of the respective ICSD and a partner custodian. The client can identify securities that “are eligible to be swept, by power of attorney (PoA) granted to the ICSD, from the mutual customer’s account … to an omnibus account that the ICSD has at each respective partner custodian.”
Here again the timing and frequency of information updates that will be made available to the mutual customer for its collateralization purposes may vary wildly by virtue of the different technical systems involved, and the settlement rules both of the partner custodian and the local market.
Beyond the consolidation of information or of assets, there may be need for a system in which available but ineligible securities may be exchanged for other securities that meet eligibility criteria in order to fulfill particular collateral obligations. This process is dubbed “collateral transformation.”
There are different ways of achieving this.
One of those ways is illustrated by the three boxes above, (a simplification of “Diagram 7” in the CPMI document.)
The party in the left-hand box provides the party in the center box with cash in return, say, for corporate bonds (DvP). The party in that central box then provides this cash to the party on the right in return for sovereign bonds. Such transactions are of course not new ideas and, as CPMI observes, the central box is typically a firm with different offices/department that may not communicate regularly with one another, and those transacting to the right or to the left may not be aware of the link between the two transactions. Counterparty A started out with corporate bonds and now has more often collateral-worthy assets, sovereign bonds.
What is new is not such transactions, but the marketing of such transactions specifically to meet regulatory requirements, now that there are detailed regulations about, for example, the quality of collateral that must be offered to CCPs.
I’ll wrap up here, simply saying that if these brief observations drawn from the report have piqued your interest at all, then the document as a whole may prove to be, for you, a valuable resource.