Collateral should be available at the right time, at the right place, in the right quantity and quality to all financial market participants, on a global scale.
Godfried De Vidts
Chairman of European Repo & Collateral Council
The International Capital Market Association, Switzerland
In 2009 at the Pittsburgh G20 Summit, leaders agreed to mandate the clearing of standardized OTC derivatives through central counterparties (CCPs). This was a first step to recognizing that creating a safe environment for too-big-to-fail/too-big-to-rescue institutions depends on the flow of appropriate collateral. Since then an extraordinary number of regulatory initiatives have impacted collateral flows, but 10 years later are there reasons to hope that we are at last in sight of a flexible system to deliver appropriate collateral as a robust underpinning to markets that can benefit the economy?
In preparation for a previous legislative program with the election of JC Juncker as President of the European Commission, I wrote an article entitled “Outlook for 2013 – Regulatory cliff or collateral cliff? Is there a difference?” Reading this again, my first impression is that I could just change the date and re-publish it now! Although that might be a little unfair to all those in the financial industry working hard to make sure markets can function optimally, the wheels of change really move very slowly in Europe. But in the last five years, the buy side has woken up and together with the banking industry (sell side), I feel that awareness of shortcomings in the legislative and regulatory work of the last 10 years is slowly growing.
There is light at the end of the tunnel. Since early this year there has been a remarkable change in rhetoric from officials. The Capital Markets Union project has so far failed to deliver concrete results, but workshops have been held with industry (buy & sell-side) to try to identify where things have gone wrong, what can be improved, and where the emphasis should be for member states, Parliament and the Commission over the next five years of the new legislative program.
Have recent Brexit-related initiatives to avoid a cliff edge effect for financial services also been encouraging? It’s certainly not perfect, but various trade bodies are working hard to make sure the risks are understood by the authorities and stop-gap measures are being put in place. In particular, work previously conducted on the final IM phases for initial margin requirements for non-cleared derivatives has seen changes. The huge holdings of bond collateral by the ECB due to the QE program, with a possible extension, is factored in by all. As buy-side participants are looking to access central counterparties either directly or through sponsored clearing, awareness of stumbling blocks is increasing, and they are being discussed. The industry is engaged with Basel/FSB policy makers re the wording around non-cash collateral. An enormous effort is being made by the industry to implement the extensive SFT-Regulation reporting requirements, which will hopefully help regulators to better understand the collateral flows. The nuclear option of the CSD-Regulation mandatory buy-in obligation is still at the top of the agenda. Expansion of other collateral types is being looked at, equities in particular. Revisions to leverage ratio Pillar 3 disclosure requirements are being actively discussed to require the use of daily averages over the reporting quarter and avoid the quarterly disruption of collateral availability to the buy side.
Collateral should be available at the right time, at the right place, in the right quantity and quality to all financial market participants, on a global scale. 2019 should see regulators gain better understanding of the Short-Term and Long-Term trends of use of collateral. Failing to continue in the next legislative phase to cater appropriately for the many demands on collateral would jeopardize the essence of the regulatory reforms started 10 years ago. In addition, our political masters are looking at CMU, the initiative of the German/French/Dutch – the CMU High-level Group shows there is a willingness to at least identify where member states can make a difference. Bringing this all together will be a valuable first step.