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Is High Liquidity Collateral the Only Option Now?
The financial world is arguably becoming more transparent and taking on a new shape. Does this necessarily mean that in the near future the only applicable collateral will be cash and easily liquidated assets?
Though there are a variety of asset classes that can be accepted as collateral, the trend that we are observing is for High Quality Liquid Assets. Limiting some of the asset’s value, due to applied haircuts, pushes companies as a consequence to spread their resources in order to acquire more cash. Jurgen Lemmen from Universal Investment confirmed this notion, saying:
”Cash is more attractive from the operational point of view than securities”.
Hear more from Jurgen Lemmen at the Collateral Conference 2017
Cash as collateral is likely to expand in the future, and some firms might have to re-evaluate their trading markets. The profitability of institutions is largely dependent on the daily monitoring of liquidity, which forces companies to develop new internal systems that would allow for cut-off times in international transactions. This time-consuming process leads many asset managers to “maintain a lot of cash with negative interest” according to Lemmen.
APG Asset Management Team manager Guido Verkoeijen gives the biggest challenge as coming from trying to comply with regulatory requirements whilst at the same time ensuring the smooth daily running of operations. This further supports “the dark side” of more transparent trading, where both sell-side and buy-side companies race against a timeline to set new procedures. Lemmen further notes that the “processing and settlement of securities is still slow, complicated and cost intensive in comparison with the movement of cash.” This supports the view that eligible collateral is in the process of moving towards liquid assets with cash as the top option.
The result of a survey conducted by BNY Mellon in June 2017, provides some insight into how buy-side companies are adapting. Liquidity is one of the main topics and 47% of participants see the demand for high-grade collateral as the main challenge in OTC derivatives operations, thus leaving the companies with only a few liquidity options after traditional options are no longer viable:
- Dealer relationships
- Non-dealer counterparties
- P2P platforms
- Clearing models
All of the above-mentioned methods require a great deal of internal re-organization, and the necessary evaluation of collateral resources that would be practical for OTC transactions. It is hard to imagine whether collateral management will only comprise of High Quality Liquid Assets in the future, or if processes will become effective enough to include other asset classes. Whatever the case, EMIR implementations bring about truly turbulent times in the current financial world.
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