Throughout 2013 there was a gradual realisation that the previous year’s scaremongering about the so called ‘collateral crunch’ was unfounded. It is now better understood within the markets that there exist rich pools of high quality collateral that are
adequate for meeting the needs of the various regulations imposed since the 2008 crisis. However, availability and access are not synonymous. Although there may be enough collateral, some firms will find it difficult to mobilise.
In order to tap into and benefit from these rather inaccessible pools, firms will need to invest in market connectivity and triparty infrastructure – in effect, the ‘plumbing’ of the industry. Plumbing is the mechanism for liberating and mobilising collateral
pools and, as firms will have to find an additional $2tn – 11tn of assets to meet clearing and non-cleared collateral regulations, plumbing will be a crucial component in the new regulatory world.
Most market participants will be able to tap into plumbing provided by the International Central Securities Depositories (iCSDs), such as Euroclear’s Collateral Highway and Clearstream’s Liquidity Hub with reasonable ease. However, custodians without their
own triparty capability face more of a challenge. Not only will they need to interface to iCSDs infrastructure, but they will also need to develop sophisticated collateral management tools to attract and engage their customers, giving them full transparency
on their exposures, encumbered and excess margin, whilst highlighting opportunities for collateral optimisation.
Anticipating these challenges, some custodians have been investing for years to build market leading infrastructure. Such firms are ready to go and are in a strong competitive position so by and large the industry’s collateral infrastructure is now in place.
As with any new plumbing, there may be some leaks from narrow pipes and new joints in the early days, but these will be undoubtedly be repaired quickly. But others are still developing their response, and if the regulatory implementation dates keep moving
back they have a chance to catch up, provided they act quickly and decisively.
Whilst fears of a collateral crunch will hopefully prove to be false, there is still the potential for a collateral crisis to arise. We are already seeing early symptoms of a potential on-boarding crunch for buyside clients who leave it too late to partner
with external service providers. Just as some firms waited too long to implement their trade reporting solutions, some will leave collateral management too late as well. When such firms finally attempt to connect to the industry infrastructure they will discover
that they’re at the end of a very long queue. Custodians will always prioritise their platinum clients, so they must help their non-platinum clients to engage early to avoid getting left out.
Firms that require access to the collateral plumbing network should have already contacted their preferred solutions providers. Those that haven’t yet done so run the risk of missing regulatory deadlines, and may even be forced to draft in the services of
the ‘emergency plumbers’ in order to be able to continue doing business… and we all know how expensive they can be!